Real Estate investors should take note.
When selling a property, there are 4 traditional ways to receive the proceeds. They are to cash out, a 1031 exchange, owner financing and an installment sale. Each has its appropriate situation but also has its pitfalls which could result in the sales proceeds becoming immediately taxable to the seller. When the proceeds become taxable, the seller can be faced with a 15% capital gains tax, state tax in 43 states and a 25% rate on depreciation recapture.
As we all know, recent health care legislation has mandated the hiring of 16,000 new IRS agents. When one of those agents comes knocking on your door, it will not be to take you to lunch. It will be to take you to the cleaners so it is incumbent upon each of us to take whatever actions we can to protect our assets from erosion caused by taxation at various levels of government. To that point, there is a 5th option when selling a property and that option is called the Deferred Sales Trust.
The Deferred Sales Trust was created to allow the seller of highly appreciated real estate defer the capital gains tax, state tax and some depreciation recapture for as long as the seller would like. The DST is a tax compliant installment sales contract with a third party trustee. The DST gives the sellers the opportunity to take illiquid assets, sell them,defer the upfront tax bill, create a tax efficient income stream while possibly eliminating the estate and gift tax for their heirs with additional planning.
There are a number of planning opportunities for using the DST. For example, an older couple has worked their farm for a number of decades. The kids are gone and now the parents would like to sell their property and move closer to the grandkids. Because they have owned the property for so many years, their basis is extremely low so there will be a large portion of the sales proceeds that will become taxable. After talking with their CPA, they decide that the tax liability is too great to sell so they decide not to and will leave the farm to their kids to do as they wish when they pass on. The Deferred Sales Trust may be the answer. The parents/sellers can find a buyer, sell their farm using the DST to defer the taxation and generate a larger retirement income than previously possible. Now the parents are free to live the lifestyle that they would like by moving closer to the grandkids and exacting revenge on their kids by spoiling the grandkids to heights previously unknown to mankind.
A second planning opportunity concerns 1031 exchanges. A 1031 exchange is a wonderful opportunity for the seller of real estate to defer taxation while at the same time buying another property. Unfortunately for a variety of reasons, some 1031 exchanges fail and the proceeds from the sale of the original property now become immediately to the seller. A Deferred Sales Trust may prevent the failed exchange from becoming immediately taxable. When an exchange fails, the qualified intermediary can be directed in advance to send the proceeds to the DST and not to the seller. By doing so, the failed exchange is not immediately taxable and the seller/taxpayer is “still in the game” to buy more real estate in the future without being encumbered by IRS Section 1031.
There are additional planning opportunities using the Deferred Sales Trust that can be discussed at a later time such as selling a highly desired property in an auction and deferring taxes. Let me leave with 2 thoughts. First,Winston Churchill once said, “To build may have to be the slow and laborious task of years. To destroy can be a thoughtless act of a single day.” A famous Hollywood actor once said, “I’m proud to be paying taxes in the United States. The only thing is- I could be just as proud for half the money.” All he had to do was call me.
David S. Fisher, Creative Real Estate Strategies
Consult your tax advisory when selling your Real Estate.
Deferred Sales Trust