"IRS Approves New Tax Deferment Program" - 1031 Exchange Without a Replacement Property?

For years, investors have taken advantage of the 1031 exchange as a method to delay or defer capital gains taxes on the sale of an investment property. By completing an exchange, the investor can sell or dispose of an appreciated investment property, use all of the equity to buy a like-kind property of equal or greater value, defer the capital gains tax and leverage all of their equity into a replacement property. The 1031 exchange is one of the last great vehicles to build wealth and save on taxes.

There still exists the investors who do not acquire a replacement property. Maybe the next move may be difficult to find the right property. The specific time-frame or an undesirable market is not conducive to executing an exchange? That investor may just want to move on with life, dispose of the asset without a replacement, but still not pay all of the capital gains upfront. Is there a solution?

There was such a solution called the private annuity trusts (PATs) which could be used to avoid capital gains taxes by transferring the title of a property to a trustee prior to the sale. Once the trustee sold the property, the proceeds from the sale would fall into the trust and then payments would be paid to the beneficiary. Most often, the trustor and beneficiary would be one and the same, therefore allowing the beneficiary (the original title holder) a method to collect payments while avoiding any upfront capital gains tax. In the fourth quarter of 2006, however, the IRS ruled that PATs were being used inappropriately to defer capital gains and estate taxes and could no longer be used in this manner.

The deferred sales trust (DST) has become the replacement strategy for the private annuity trust. Very similar to the PATs, the deferred sales trust, recognizes capital gain, but it is deferred over a predetermined period of time that is planned in advance of the sale.

Here is a breakdown of the process for a DST:
1- Private third-party company forms a trust
2- Owner sells the property to the trust
3- Trust and owner (beneficiary) put together an installment contract
4- Contract promises to pay beneficiary predetermined amount over an agreed period of time

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Example of DST vs. a Typical Sale (California)
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Assumptions:
Owned for 8 years
Purchase Price: $ 2,750,000
Sale Price: $ 4,100,000
Loan Amount: $1,750,000
Recapture Depreciation $ 800,000
Basis: $1,950,000
Taxable Gain: $2,150,000

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Standard Sale Transaction:
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Net Sale Proceeds: $ 2,350,000
Federal Tax (15%) $ 322,500
State Tax (9.3%) $ 199,950
Proceeds after tax: $ 1,827,550
Annual Interest of $ 146,204

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DST Transaction:
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Net Sale Proceeds: $ 2,350,000
Annual Interest of $ 188,000

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DST income difference of 22% or $41,796
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As you can see, the deferred sales trust can be a vehicle to defer taxes without having to acquire a new property and in the long run may actually be a more viable and lucrative choice than other tax deferment methods. To find out more information, contact a commercial real estate broker or tax professional in your area.

The 1031 Exchange Alternative - How to Sell Commercial Real Estate Without Paying Capital Gains Tax

When it comes to tax planning, eliminating the capital gains and depreciation recapture taxes on the sale of appreciated commercial real estate is a hot topic. In fact, there are countless numbers of would be sellers who don't because of this. Many would be sellers simply want out of the real estate - they're tired of landlording, fixing toilets, and never ending maintenance and management. They would like to sell, reinvest elsewhere and simply receive a check, spending their time doing what they like. Unfortunately, the only way to get out of real estate without losing control of the "asset" is to sell it outright-and pay the tax. You could implement a property exchange (1031) directed by a Qualified Intermediary, but the key word here is "exchange"- you've simply traded one for the other. You're still in real estate.

Other sellers may want to buy more real estate, but don't want the restrictions and rigid timeframes of a 1031 Exchange. What can you do? Is there any other way to get out without paying these taxes? The answer may lie in the use of a specialized trust, designed in accordance with strict IRS guidelines and a private letter ruling. It can be used as a tax deferral tool and as a 1031 Exchange alternative.

This tax deferral tool could, if implemented, save you tens of thousands of dollars in taxes that you would have otherwise voluntarily paid to Uncle Sam. These are dollars that you can use to generate a higher income and to potentially profit from. It's as if Uncle Sam let you keep the tax dollars, invest them somewhere, and use the income they generate for you. It really is like "free" money. As a result, it comes as no surprise that this strategy is gaining popularity among owners of highly appreciated commercial real estate who have properties marked for sale. With a better understanding of the process, you too can take advantage of this program.

The process begins when an owner of commercial property sells it to a special trust owned by a third party company. Then, the trust sells the property to a buyer. There are no taxes to the trust because the trust "purchased" the property from you for what it sold it for. At the completion of the sale, the money from the buyer is now in the trust. At this point, the trust begins to "pay" you. This payment isn't is a lump sum, but a payment contract, referred to as an "installment contract". This contract is similar to that of an Installment Sale, but without the restrictions and with many added benefits. This contract promises to make payments to you over a pre-specified period of time.

You can choose when and how payments are to be made. You may not need the income right away-or ever. It's up to you. The tax code requires the payment of tax to the IRS only when you begin to take installment payments. Therefore, tax is paid incrementally. It is paid in proportion to the number of years in your "installment plan". In the case of a 1031 exchange, money for a new purchase can be acquired anytime from the sale of the old property and use of this trust without paying taxes, thereby eliminating the restrictions and rigid timeframes of the 1031 Exchange. Either way, your equity is no longer "tax trapped".

This special type of trust gives you the potential to generate much more money over the long run than you would with the taxes lost in a direct sale.

This may be the most suitable or appropriate tax strategy depending on your circumstances. Contact the author for a complimentary tax analysis and to discuss your specific circumstances and goals.