Founder, CEO of Blue Lake Capital LLC. Helps passive investors grow wealth through real estate. Podcast Host: REady2Scale.
According to the U.S. Census, there are ten thousand Baby Boomers entering retirement age each day and by 2030 all Baby Boomers will be 65 and older. In preparing for leaving the workforce, many are considering selling their real estate assets to help fund their retirement. The problem is that they often hold off on those sales due to tax liabilities.
There are some ways to help high-net-worth individuals, brokers and real estate syndicators and their clients achieve capital gains tax deferrals while keeping the clients’ money working for them and preserving their wealth. This can be accomplished through two distinct strategies: 1031 exchanges and deferred sales trusts.
While many investors are familiar with 1031 exchanges, not many are aware of a deferred sales trust. When you purchase a property and sell at a high price, the gain you earn can be taxed anywhere from 30% to 50%. To defer taxes, investors can use the 1031 exchange when they sell a property. Rather than paying long-term capital gains on their profits, the 1031 exchange allows them to take those funds and use them as a downpayment on a new property.
While the 1031 exchange is perfectly legal, it does have some restrictive rules that deter some investors from using it. For example, it requires that the new property you exchange must be a similar asset. If, for example, you’re selling a multifamily property, you can’t take the proceeds and buy a new primary residence.
Timing is another issue. A 1031 Exchange requires you to identify the property that you plan to buy within 45 days of selling your primary property. In addition, you must close on the new property within 180 days. While that could be seen as a long amount of time, in commercial real estate it’s fast. It forces some buyers to bid up properties just to meet the deadline, and they may end up acquiring a property in haste that isn’t a top performer.
Deferred Sales Trust
With a deferred sales trust, you can sell your property at a high price, put the funds in a trust and purchase a new property whenever you choose. Another advantage is diversification. Due to the uncertainty in the marketplace, now is a good time to diversify, whether the funds from the sale are put in stocks, bonds or a completely different real estate asset class. 1031 exchanges don’t allow you to do this. A deferred sales trust is basically an installment sale, or better known to real estate investors as a seller carry back.
Another advantage to using a deferred sales trust over a 1031 exchange is that you can create a new depreciation schedule. If you own a multifamily property for 27.5 years, it’s fully depreciated. With a 1031 exchange, the depreciation schedule goes with the property sale. With a deferred sales trust, you get a brand-new depreciation schedule.
A deferred sales trust also lets you park your money while you search for a new investment, without any time constraints. You can put the money in a conservative portfolio of liquid investments to preserve the wealth and achieve a reasonable rate of return on the money while it’s waiting to be used.
In addition, it helps to get people out of debt, because the proceeds of the sale aren’t being used to immediately purchase a new property with a new mortgage. Instead, the funds are being invested and are liquid, which is especially beneficial if someone is considering retirement. A deferred sales trust isn’t just for Baby Boomers and retirement, nor is it limited to real estate assets. You can use it to defer taxes on the sale of a high-end primary home, private professional practice, bitcoins or a business.
While many real estate investors would like to sell their properties once they reach retirement age, some hesitate because of capital gains and other tax liabilities. For example, if the property was purchased years ago, the price has increased substantially, and they could be taxed anywhere from 30% to 50%.
Instead of paying high taxes, many opt for a 1031 exchange so they can use their profits as a downpayment on another property, though they must then accept the restrictions Another option is the deferred sales trust. It allows you to sell your property at a high price and purchase a new property whenever you choose. The depreciation schedules differ between these two options — adding another layer to the decision-making process. Both options offer a pathway to preserving wealth for the many Baby Boomers now entering retirement.
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