Self Directed Installment Sale Vs 1031 Exchange - When a SDIS Makes Sense (Part II)

In the last article, I pointed out when, as a real estate investor, doing a 1031 Exchange on the sale of a Real Estate Property may not be your best option.

So, let's assume you do want or need to sell a real estate investment, don't want to do an exchange, and don't want to pay a huge lump sum capital gains tax payment of 15-40% on your gains. Now is the time to see how a Self Directed Installment Sale can save you money.

It's important to know that you don't avoid paying your capital gains tax obligation, you just get to spread out the obligation over many years. The total of years is typically between 10 to 30 and it is possible to defer taking payments for a while depending on your circumstances.

So, how does that help you? Well, if someone were to offer you a 0% interest loan on let's say $300,000.00 for the next 30 years, and you only had to make minimum payments, would you jump at the chance? Most people sure would. Think of how you could invest that 300K so that you could enjoy the benefit of the interest it accrued. This is effectively what a Self Directed Installment Sale does for you. It allows you to keep most of your gains working to your advantage, while paying back the money owed to the IRS over a long period of time.

This also holds for the depreciation recapture if you owned your property for a long period of time and depreciated it according to a schedule to realize annual tax advantages of owning investment real estate. This is not true for accelerated depreciation taken.

If you do not put a tax strategy in place and sell outright, not only do you owe capital gains tax, but you also owe depreciation recapture, which can be another 25-35% of your total depreciation taken over the ownership cycle of your investment.

And, you will avoid the possibility of the dreaded Alternative Minimum Tax trap. This is something else that may catch you by surprise when you least expect it triggered by your outright sale of property. This could mean having other legitimate tax deductions disqualified and a higher tax payment owed by you.

As you can see, it's definitely worth it to consult with an expert in Capital Gains Tax saving strategies before you make the decision to sell your real property.

The SDIS can also work with the sale of a second home, vacation home, business, collection, or even your primary residence. With these assets, a 1031 exchange is not an option.

Self Directed Installment Sale Vs 1031 Exchange - When a SDIS Makes Sense (Part I)

Real Estate Investors tend to be hard core. There is nothing like having your money invested in property you can touch, visit, renovate and watch gain in appreciation.

You may have heard the term "Swap till you drop". What this term means is that as an investor,you sell your real property and exchange it for another of equal or greater value, and continue to do this until you die and leave the assets to your heirs. This does (under current tax law) allow you to avoid paying capital gains tax and recaptured depreciation forever. And, your heirs currently inherit it at the value at the date of your death. They do not pay capital gains tax and depreciation, except if they sell it over the value it was at death.

This is a good thing.

However, there is going to be a time to exit the real estate investment phase of your life. Let me give a few examples of when this might be the case.

1. You have accumulated a number of investment properties and reach a point in life you want less hands-on management responsibilities.

2. You want to slow down a bit during retirement and actually want to use some of the equity you have worked so hard to accumulate to improve your income and lifestyle.

3. The market conditions are ripe to sell, but purchasing another property of equal or greater value doesn't make sense.

4. Economic conditions warrant sale. Perhaps need for long term care for you or a member of your family.

5. Personal circumstances, such as need for additional income, debt payoff, tax consequences, property division, etc. warrant the need to sell.

6. You need to do some estate planning and need to remove some of your assets from your estate so your heirs won't have a huge estate tax obligation.

If any of these prevail, a Self Directed Installment Sale may be your best option. A SDIS will allow you to spread out your capital gains tax burden over many years, and trigger what is effectively a 0% interest long term loan from the government. How often do you get this kind of opportunity?

Part II will explain more of how a Self Directed Installment Sale can make a huge difference when any of the above circumstances might arise.