When you invest in Real Estate, you know that when you sell, you have to deal with Capital Gains Taxes.
Traditionally, there have been three options:
– Sell & pay the Capital Gains Tax
– Do a 1031 Exchange
– Do Nothing
Rising Real Estate values have compressed Cap Rates, ie 3% or lower. If a seller wants to sell while prices are high, but is unable to find a suitable option for a 1031 Exchange, there is another option:
Deferred Sales Trust
The Deferred Sales Trust provides the opportunity to
– Diversify your portfolio
– Take advantage of record sales prices
– Convert the real estate into other investment
Richard Hershey with WeReduceTaxes.com explains how a Deferred Sales Trust provides an alternative for Real Estate Investors
The Deferred Sales Trust process works similar to a 1031 Exchange with the use of a neutral 3rd party intermediary.
There are 3 steps to the process:
1) Buyer & Seller come to agreement on the sales price.
2) Seller transfers the property into the Deferred Sales Trust.
3) The Trust Sells the property to the Buyer.
The proceeds are transferred from escrow to a qualified 3rd party, “accommodator”.
The Seller does not take possession, nor taken “constructive receipt” of the sale proceeds.
During the first 45 days, after sale, the Seller is able to pursue a a suitable property for 1031 Exchange.
If no suitable option is found for a 1031 Exchange within 45 days, the 1031 Exchange option expires. This is referred to as a “Failed Exchange”.
Given that “constructive receipt” has not occurred, the 3rd party “accommodator” can transfer the sale proceeds directly to the “Deferred Sales Trust”.
The proceeds include the gain. But since “constructive receipt” has not occurred the taxes can be deferred if held in a “Deferred Sales Trust”.
Once the proceeds are in the Deferred Sales Trust, the investment options are fairly liberal. The investment returns pass to the Seller as “Ordinary Income” and are taxed accordingly.
A motivating reason to consider a Deferred Sales Trust, look at the potential difference in income generated when the Capital Gains Taxes are deferred:
Sale of a $2,000,000 property
After Capital Gains Taxes are paid:
5% return on $1,000,000
If Capital Gains Taxes are Deferred:
5% return on $2,000,000
If the Seller elects to receive some or all of the Principal & Gain, the Seller will be required to pay the prorated Capital Gains.
The Benefits of the Deferred Sales Trust:
Ability to Sell Real Estate Investment at record highs.
Diversification; opportunity to invest in alternative investment vehicles
Different life style; ability to get out of the property management business
If the property has been owned for a long time, it is conceivable that the property is fully depreciated, and in need of significant capital investment
The Capital Gains are due upon liquidation of the the Trust, if when that occurs.
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