What is a CAPS Trust/Asset Exchange Structure?

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CAPS is an acronym which stands for a Commercial Asset Protection Sale whereby business and real estate owners utilize an irrevocable trust to defer capital gains on the sale of their business or real estate. The structure started in Florida and was previously reserved for high net worth clients of prestigious law firms who were helping clients defer taxes on large transactions. It is also known as an Asset Exchange Structure (AE).  The CAPS and AE teams are bringing the structure out of obscurity, improving it, and making it more affordable to clients.  We seek to educate Clients, CPA's, and Tax Advisers regarding the benefits of the structure to help people minimize their taxes when they sell their business or real estate.

 

The concepts of Installment Sales (IRC Section 453) and Irrevocable Trusts (Magna Carta, adopted in 1215) aren’t new, but combining the two concepts for asset protection and tax deferral has been used successfully for over 20 years.   

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How a CAPS Trust/Asset Exchange work

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With a CAPS Trust or Asset Exchange structure, there is a buyer and a seller, just like a conventional sale; however, the business or real estate is sold to an irrevocable trust (Sale 1) which immediately sells the business or real estate to the buyer (Sale 2). From a buyer’s perspective it is seamless: he/she purchases the business under the same terms, only it is purchased from “XYZ Trust” instead of “ABC Seller”.

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From a seller’s perspective the transaction is structured as an installment sale.  The trust gives the seller a secured promissory note. This note has flexibility of payment and terms, so the seller can determine his/her cash flow needs on a monthly basis and structure the payments based on those needs. The note creates an income stream for the seller, secured by the assets of the trust. The seller pays taxes as he/she receives the income on an installment sale basis in the future. This aspect of the structure is governed by installment sale tax law.

 

When the business or real estate is sold to the irrevocable trust, the taxes are deferred (not eliminated) for the seller.  The trust sells the assets for the acquisition price so zero gain is recognized with Sale 1 and Sale 2.   Since the sale to the trust isn't a taxable event, zero taxes are due on the sale date. This gives the seller more money in the form of "pre-tax" dollars to invest over time.  The trust proceeds can be invested in stocks, bonds, marketable securities, annuities, life insurance policies, etc. to provide income to the seller which is paid through the note on an installment sale basis. 

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The Trust fulfills 5 purposes:

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1. Collects and Maintains.  The pre-tax proceeds from the sale are protected and maintained using checks and balances outlined in the trust documents. The trust is managed by Nevada Trust Company.  The accounts are held at TD Ameritrade.

2. Asset Protection.  The trust provides valuable protection of the pre-tax proceeds from creditors just like other trusts used for Estate Planning and asset protection purposes.

3. Capital Gains Tax Shelter.  The trust shelters the pre-tax proceeds from capital gains taxes until they are dispersed to the seller.  The seller can pay the tax in the future over time instead of all at once. The seller can also take advantage of the tiered tax structure for capital gains to reduce future taxes by shifting more income into the lower tax brackets. 

4. Tax Deferral and Installment Sale.  The taxes aren’t eliminated, but they are deferred like they are with a 401k until the proceeds are received on an installment sale basis.  Investing pre-tax dollars accelerates returns. Having the use of more money over time means higher growth and better returns over time.   

5. Invests for Secure Growth.  The pre-tax proceeds are managed by a Registered Investment Advisor (RIA) who is hired by the Trustee to manage and protect the money.  This RIA has a fiduciary duty to the Trustee to only make investments that are “commercially reasonable” including investment grade securities, publicly traded stocks, bonds, life insurance. etc.  Seller input is used to make the investment decisions to protect the collateral for the note. ​

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Benefits

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The CAPS Trust/Asset Exchange structures are powerful tax reduction/deferral tools for 2 reasons:

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1. The seller receives the use of “before tax” proceeds for up to 20 years to put more money in their pocket.  The seller would normally be forced to pay 100% of the taxes in full up front.  Sellers can use these pre-tax dollars to make money over time, even enough money to pay a percentage of the taxes in the future as money is paid out of the Trust. 

2. ​CAPS allows the seller to plan when the taxes are paid and take advantage of tiered tax rates.  A seller can effectively lower their tax rates on a portion of the tax that would have been due if the taxes were all paid at closing. 

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For example, we recently helped Adam and Julie defer $1.2 Million on a $5 Million sale.  They now have the use of $5 Million instead of $3.8 Million. By putting their tax deferral to work, they plan to use pre-tax dollars to make enough money on their tax deferral to reduce their future tax bill. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adam and Julie defer $1.2 Million of taxes and endorse the CAPS Trust/Asset Exhange structure

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Recent successful transactions

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Client Deferred $2.3 Million

Client Deferred $2.8 Million

Client Deferred $1.2 Million