Eight ways to sell your investment property.
COURTESY OF ROBYN WONNELL
SOCAL APARTMENT BROKERS, KW COMMERCIAL
- The proceeds from the sale are placed into a third party, qualified intermediary, similar to an escrow.
- The gain on sale is reinvested into a like-kind real estate property which is much broader than it sounds. An apartment building can be exchanged into an office building, retail center, industrial complex, hotel or specialty real estate, single family homes for rental purposes, raw or improved land, another apartment building, and more.
- The purchase of the new property is usually of greater value than the relinquished property, but caveats may apply. If cash or ‘boot’ is taken, then taxes on that amount may apply.
- A reverse exchange is one where the ‘up leg’ property is purchased before the ‘down leg’ property is sold.
- The replacement property or properties must be identified within 45 days.
- The replacement property must be acquired/closed within 180 days from the sale of the original property.
DSTs – Type 1 – Delaware Statutory Trust:
- Exchange full and direct ownership of your apartment community into a fractional ownership interest into one or more of a variety of real estate assets such as shopping centers, larger apartment building, Hotels, various types of Co-ops, and more. Tenants in Common or TICS are also a type of DST.
- Proceeds of relinquished property are placed with a Qualified Intermediary who then invests in the Delaware Statutory Trust on behalf of the investor.
- Capital gains taxes are deferred until the DST is liquidated with the sale of the asset, typically 5-10 years.
- Investors have the option of to do another exchange, and another and eventually pass on the investment to heirs with no capital gains tax.
- There’s no management involvement.
- The asset is not liquid until the time it’s sold or exchanged again.
DSTs – Type 2 – Deferred Sales Trust: This is very different than the above DST.
- Investor sells real estate asset to a Qualified Third-Party trust in exchange for a promissory note or deferred installment contract.
- The investor is the beneficiary of the contract and sets up a payment plan of how they wish to receive proceeds.
- This contract usually lasts 10 years before the taxes must be paid, reinvested or renewal of the contract can take place.
- The capital gains taxes are incurred according to the plan put in place with the trust agreement and not when the property was sold.
- The trustee then sells the real estate asset to another investor and uses the proceeds to make payments on the promissory note.
- The Trustee cannot be a relative or someone personally close to the investor. It must be someone truly independent.
Charitable Trusts: There are several types and variations. These are the basic ones.
- Charitable Remainder Trust or CRT – An investor donates assets that can be highly appreciated or non-income producing to the trust. That trust makes at least an annual payment back to the investor or another designated non-charitable beneficiary for the term of the trust.
- The period of the CRT can be for the beneficiary’s lifetime or up to 20 years.
- When that time is up, the remaining assets and any appreciation goes to the charity.
- Those assets can be sold within the trust and not incur any capital gains tax.
- Charitable Lead Trust or CLT – Is very similar to a CRT with the main difference being that the annual or agreed upon payment goes to the designated Charity first.
- After the trust period ends, the remainder goes to the designated non-charitable beneficiary.
- Both types of trusts can be funded with real estate and other types of assets such as stocks, bonds and mutual funds. More complex assets are increasingly going to charitable type trusts such as private C and S corporation stock, LLC and LP interests, and personal property like artwork and collections.
- Setting up a Donor-Advised Fund along with your Charitable Trust provides flexibility to change charitable beneficiaries and other aspects of the trust.
- A donor or investor can have split interest trusts as well. The trust can donate to charity while paying for a life insurance policy that will benefit a non-charitable beneficiary.
- Some benefits of charitable trusts are: 1) Preservation of the value of highly appreciated assets. 2) Reduce gift taxes. 3) Income tax deductions. 4) Reduce estate taxes.
Private Annuity Trust or PAT:
- The owner creates an irrevocable trust prior to the sale of the property or asset.
- The investor transfers the asset into the irrevocable private annuity trust.
- The PAT sells the asset to the ultimate buyer, and since the PAT’s basis in the property is the same as the sales price, there is no gain or taxation to the PAT.
- The PAT then reinvests the proceeds into a diversified portfolio to provide an income which can be deferred until the age of 701/2, upon which the taxpayer must begin taking distributions.
- The income is therefore taxed on a tax advantaged basis.
- The assets in the PAT are protected from creditors and lawsuit judgments and the remaining assets are passed on estate-tax free to the heirs.
Installment Sale or Seller Carry Back: There are variations on the Installment Sale. This is the most common type.
- The seller of the asset may or may not keep title to the property while accepting some amount of up front or lump sum from the buyer.
- The remainder of the sales price is paid over time at an agreed upon interest rate.
- The term of the contract can be made to suit both the needs of the seller and the buyer.
- Most contracts provide for the return of the property should the buyer default on the payments.
- Most contracts allow for some kind of prepayment penalty should the buyer wish to pay off the loan ahead of schedule; however, since the prepayment of the loan may trigger unanticipated capital gains by the seller, those penalties may be enough to cover those taxes.
- Loan assumption clauses may be easier to contract without an institutional bank involved that has stringent underwriting criteria to follow.
- This type of contract can allow an otherwise unqualified buyer to obtain a property with huge potential upside that the buyer would otherwise have to exchange into several more times prior to the agreed property.
- The seller may choose to accept a lump sum that mirrors his or her basis in the property.
- The seller then pays capital gains on the difference as received on a periodic basis which is agreed to upfront.
Asset Backed Installment Sale or ABIS: This is the newest alternative that we’ve found.
- It follows IRS Code 453 and the spirit of the law regarding separation of fund relationships.
- Has 2 years of tax and accounting research and selling banks on the idea.
- Uses legitimate 3rd party lender, and therefore true segregation of funds.
- The seller and buyer agree on purchase price and terms of offer.
- The purchase contract is then assigned to an Accommodator (like an exchange) and another agreement is signed between seller and Accommodator.
- The total proceeds are invested with the Accommodator which pays an agreed upon rate to the client based on the Treasury Rate plus 3%.
- The proceeds are reinvested with 3rd party lenders such as Morgan Stanley and Goldman Sachs and used as collateralized lines of credit.
- The Capital Advisor that works with the Accommodator reinvests these funds with the above for a higher return due to its diversification.
- That return minus annual fees gets reinvested again and again.
A Sale vs. the other methods:
- Sometimes in our lives we want to just make things simple and move on to our next phase in life. We don’t want to be bothered by what can seem like a complicated way to ‘get rid of a problem’. Perhaps we have had issues with the IRS before and wish to avoid any potential difficulties this time around. Maybe an investor just believes in paying Uncle Sam as she/he goes. ?Stranger things have happened?.
- For all other circumstances, deferring capital gains, depreciation recapture, net investment income tax, or a variation of these, offers the best long-term return.
- Reinvesting the total proceeds including, the tax deferred amount, can allow an investor to buy a much larger property that has an equally larger return.
- This can be done repeatedly, to create long term wealth; and, depending on the amount, can be passed tax-free to heirs.
- Most people have heard of one or two ways other than the ‘pay as you go’ method, but with the ever-changing tax laws, more investment deferment products will be available.
- Make sure to find a few trusted advisors to keep you informed, before you need them.
- Do your due diligence before you agree to anything.
- This information came from several sources, and the information may be skewed towards their expertise and business marketing goals. So, please get detailed information regarding any tax deferment products you might be interested in.
- Fidelity Investments, Asset Preservation Inc., Financial West Group, Realized1031.com, Inland Private Capital Corp., and KB Capital Advisors contributed to this information.
- This information is only a snapshot of how these products works. For detailed information contact an expert in each service, along with your accountant, tax advisor, and attorney. SoCal Apartments with KW Commercial, is not a law or accountancy firm. We broker apartments.
- For a free consultation regarding the sale of your property, contact Robyn Wonnell at 951) 501-6567, 951) 304-1200 ext. 3351, or email us at Socalapartments@kwcommercial.com CalDre: 01353690
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