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Pandemic Presents Planning Opportunities for High Net Worth Individuals

Merrick Shukan, CPA, MST and Laura Genetelli, CPA, MBA

8.20.20 | Wealth of Insights

The world has changed so much since mid-March. Unemployment rates have seen record highs and the U.S. economy suffered its worst period ever in the second quarter, with the GDP shrinking by 32.9%. Despite all the trials and tribulations that have impacted so many, the COVID-19 pandemic has created financial and tax planning opportunities that are worth exploring.

Extraordinarily low interest rates provide benefits with structuring intra-family loans and refinancing home mortgages. As asset values continue to fluctuate, now may also be a great time to take advantage of depressed investment values for tax loss harvesting and Roth IRA conversions. In addition, the tax law changes enacted by the CARES Act (The Coronavirus Aid, Relief, and Economic Security Act) passed on March 27, 2020, provides enhanced charitable giving opportunities.

Intra-Family Loans
Parents can make low-interest loans to children or to trusts for the benefit of children or other family members, who may pay interest annually and the loan principal at the end of the term.

Intra-family loans typically use the Applicable Federal Rate (AFR), the lowest interest rate that can be charged on a loan for it not to be a gift. The IRS publishes three rate tiers that apply to three different terms of loan, on a monthly basis. The current AFR rates (August 2020) are .17% for short-term (0-3 years), .41% for mid-term (3-9 years), 1.12% for long-term (9 years or more). Intra-family loans are not subject to underwriting and can be made at any time and based on any terms desired, if at least the AFR rate is charged and actual payments are made.

Intra-family loans are often used to purchase shares of a family business or partnership or may fund a mortgage for a child or a grandchild. The repayment of these loans is often achieved by making annual cash gifts to the borrower from the lender, providing the borrower the liquidity to pay down the debt.

Now is a good time consider new or to review any existing intra-family loans. With AFR interest rates at rock-bottom levels, it might make sense to refinance existing debt obligations at a much lower rate.

Mortgage Refinancing
As current interest rates on mortgages reach historical lows, many homeowners are motivated to refinance. A pure refinancing on an existing mortgage at a lower rate will produce the obvious, a lower monthly mortgage payment and a quicker pay-off of principal. However, if your home is worth substantially more than the amount you owe, you may choose to take out a larger home mortgage when you refinance, resulting in getting cash back.

Be aware the ability to deduct the interest associated with a cash-out refinance will depend on how the cash is spent. Generally, if the cash is used for anything other than capital improvements on the home, or to invest in a business or income producing or other investment assets, the mortgage interest associated with the increase in the loan will not be deductible. If spent on home improvements, the overall cap on deductible mortgage debt of $750,000 will apply.

Knowing the costs associated with refinancing, how long you plan to live in the home, and how much money you will save are all important to consider before starting the refinancing process. If you do not plan on owning the home long enough to recoup the refinance costs, it will not be worth your time and effort devoted to the refinance process.

Tax Loss Harvesting
Now is a good time to review your 2020 taxable income with your accountant in conjunction with discussing your portfolio with your investment advisor. Tax loss harvesting is an investment strategy that can help reduce taxes by offsetting taxable capital gains. The idea is to sell assets that have decreased in value, use the proceeds to reinvest in similar investments, and then offset realized investment gains with these losses. If you don’t currently have realized gains, you can use up to $3,000 per year of the loss to offset capital gains or ordinary income, and the balance carries over to future years. When reviewing your portfolio for tax loss harvesting, consider investments that no longer fit your strategy. These investments may no longer have potential for future growth and can be replaced with other investments that are a better fit in your portfolio.

If you are invested in mutual funds, the return on these investments may be in the form of taxable long-term capital gains. Harvested losses provide opportunity to offset such taxable capital gain distributions.

Once you have identified which assets to sell and realize losses, you must be careful of the wash-sale rule when you identify replacement investments. The wash-sale rule disallows the loss realization if you buy the same security, enter into a contract or option to buy the same security, or a “substantially identical” security, within 30 days before or after the date you sold the loss investment.

Roth IRA Conversions
The key benefit of a Roth IRA – and why many people have them – is that qualified distributions are 100% tax-free, whereas distributions from a traditional IRA may be 100% taxable.

A traditional IRA may be converted to a Roth IRA with the consequence of taxable income recognition based on the conversion date fair market value(s);  tax is subsequently imposed on the “Roth Conversion” income, at ordinary income tax rates.   During the COVID-19 pandemic many IRA owners are faced with depressed asset values, thus, it may be an optimal time now to do a Roth conversion.

Example – if your IRA account had a value of $100,000 on January 1, 2020, but the account value is only $85,000 today, your taxable conversion today would be $85,000.  This would result in a taxable conversion of $15,000 less than if you converted earlier in the year.

Charitable Contributions
To stimulate charitable giving in 2020, the CARES Act increased the cash charitable contribution deduction limits from 60% to 100% of adjusted gross income. This only applies for cash contributions to qualified public charities, contributed during the 2020 tax year. Cash contribution carryovers from previous years continue to be subject to the 60% of AGI charitable deduction limits.

Lastly, keep in mind – the “unknowns” of the November 2020 Presidential Election and the potential for future tax law changes that could require another revisit of your investment and tax planning matters. Stay tuned for 2021 tax planning tips.

Should you have questions or would like more information regarding the planning concepts here, contact your financial advisor and Merrick Shukan at 212.331.7670 | MShukan@berdonllp.com, Laura Genetelli at 212.699.8864 | LGenetelli@berdonllp.com or your Berdon advisor.

For more information on any other matter related to the COVID-19 pandemic, please contact your Berdon Advisor.

Berdon LLP New York Accountants