Real estate investors will not spend a lifetime deferring capital gains tax by taking advantage of the 1031 Exchange to simply throw in the towel at the end of their “active” investment life. Logically, investors will seek out an exit strategy that will for the most part keep their accumulated equity intact while offering more time and less stress for a relaxed retirement.
Unlike IRA’s and 401k plans where there is little tax relief available for those RMDs (Required Minimum Distributions) Real Estate Investors that have utilized the 1031 to accumulate wealth have a variety of options available for a tailor fitted retirement. Consider the following:
Swap until you drop – Simply stated, defer all gains until you pass and your heirs will receive the inherited property with a stepped-up basis to current market value.
Exchange into a retirement residence – Acquire your future Retirement Home via a 1031 Exchange and after seasoning the property as an investment you can convert the property to your primary residence without tax consequence.
Exchange until it makes tax sense – Sell realizing gain when there is a loss to offset or simply wait until your income is reduced through retirement. Historically it was possible to Exchange out of a high tax state and into a low or no tax State and later sell, though this option has been for the most part eliminated with States like California and Oregon reserving the right to claw back what was previously deferred if there is a taxable sale.
Exchange into a passive investment (DST) – A Delaware Statutory Trust (DST) is like a Real Estate Investment Trust (REIT) that can be 1031 Exchanged. A DST is simply a separate legal entity created under the laws of Delaware to hold title to one or more income producing commercial properties. This can be any type of commercial property; apartments, retail space, office buildings, industrial parks, etc. And much like a REIT (Real Estate Investment Trust), an individual DST may hold title to multiple properties at one time. Exchanging into a DST makes great sense for Real Estate owners who no longer want the burden of active management.
Tenancy in Common Investments (TIC) – Technically this is simply multiple owners in a common investment with deeded ownership. The TIC has been around for decades and today on the Institutional level has for the most part been replaced by the DST but the ownership structure is still often used, even in the Institutional world. TIC offerings are typically present in “Value Add” properties and on the institutional level are completely passive like a DST.
Installment Sale – A “seller carry back,” a “contract sale” or a “note and trust deed” sale are all terms that describe forms of seller financing or Installment Sales. In today’s world of Savings Accounts with virtually no interest paid, simply selling, paying the tax and placing funds in a Savings Account is not a very attractive option. The primary issues that come up are typically defaults of the buyer or early payoffs. Other items of note are the fact that taxes are owed in the year of closing for any Depreciation Recapture and Debt Relief even if there has not been a single principle payment. With all the above said, Installment Sales can offer Investors a nice cash flow in retirement.
Structured Sale – Think of a Structured Sale as simply an Institutionally Structured Installment Sale. A third-party assignment company assumes the obligation to pay over the term the Investor desires. The “Assignment Company” is typically a very large Insurance Company or equivalent and therefore there is very little chance of default.
Charitable Remainder Trust – A “CRT” is a tool that enables you to give to charities while reaping financial benefits. A CRT enables you to reduce or virtually eliminate capital gains tax on the sale of an asset funding the CRT, claim an income tax deduction, receive income and make a gift to the charity or charities of your choice.
Gifting – Gifting is often the objective of Exchangors as they get older. The Exchangor may have three children and would like to acquire a property for each child to have at a later date. Bearing in mind the federal gift limits we often have clients gift portions of properties over a series of years. Although the “portion” strategy takes time and may require new deeds through the years the benefit can be huge with discounting of minority interest transfers of as much as 40% possible!
In summary, it is common for potential clients to state “I’m going to have to pay the tax at some point, why not just pay today?” To that question I ask whether they have IRAs or 401k plans, if so, why since they will have to pay? The bottom line is tax deferral is one of the most effective tools you can utilize to grow wealth! Using the options mentioned above can defer, stretch out the payment of or even eliminate taxes!
Call Equity Advantage today to find out more about keeping more of your money yours! Exchange, Don’t Sell!
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David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
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