Real estate investment has long been recognized as a steady and reliable path to the accumulation of wealth. Typical investors have repositioned their assets over the years by exchanging into larger properties. Cash flows are now exposed to a bigger tax bite, and refinancing has placed the mortgage over the basic value of a piece of property. This has created a taxable event for recaptured depreciation upon sale which, in turn, creates a cul-de-sac on the road to equity growth for the investor.
While most investors are reasonably clear on the benefits of owning income property, the rarity of investors who have developed an "end-game" strategy, future plans for the timely disposition of assets under the most favorable circumstances, is surprising. Many investors have found that their net asset values have grown far beyond estate tax exemptions, and are now subject to substantial taxes upon final disposition to heirs.
In developing a plan for the settling of assets, it is a good idea to first decide which investment traits you exhibit. Most individual investors fall into one of three distinct groups: The Ostrich, the personnot interested in going much farther than having a will and, perhaps, a living trust to hold their assets; the Blue Jay, the person interested in keeping (or spending) all they have in one lifetime; and the Owl (as in wise ol'), the person that takes a long term visionary approach, and is very pro-active about their investment real estate portfolio
Even in light of such vast financial differences, each investor type can benefit greatly from keeping abreast of market trends and estate planning tools. Here are a few options available to the real estate investor who wants to cash out of real estate with the greatest amount of after tax dollars:
? Tax-Friendly Entities. First and foremost, work with a professional in both tax law and accounting to determine your best options for holding title to your property. Choosing the right form of holding title delivers protection of equity, tax savings and flexibility in planning future benefits.
? 1031 Exchange. This tool is the most popular way to put off the tax man for another day. While most 1031 exchanges are designed to defer all the gain, some are also useful in planning a graceful exit from ownership.
? Installment Sale. When a property is settled and at least one payment is to be received after the close of the taxable year in which the sale occurs, the seller will recognize gain or profit as he actually receives the proceeds, over time.
? Lease Option. Under the lease option, the title to the property remains with the taxpayer, and a contract to sell is contained in an option. The owner of the option leases the property with the lease payment equal to the amount of interest on an installment sale.
? Exchange for NNN and Sell Cash Flows. Turn a 1031 exchange into a quality net leased investment, and borrow against the cash flows at a reasonable discount. The benefits are tax-free cash.
? Family Limited Partnerships. The formation of a family limited partnership provides a convenient way of passing on equity interests to family members at bargain basement prices. Control of the property remains with the grantor or general partner and the limited partnership interests are discounted up to 40 percent.
? Charitable Remainder Unitrust (CRUT). These are especially useful when property is fully depreciated. The transfer of ownership to a qualified charity results in no capital gains tax upon sale and cash flow for the life of the donors. The charity receives the remainder of the asset.
? Retained Life Estate. The donor receives a significant tax write off in the year of transfer, and use of the property for life.
? Family Foundation. This vehicle provides involvement in funding charitable activities and specific needs, while providing tax benefits and control.
? Private Annuity Trust. Private annuities can provide significant benefits in transferring ownership of assets from one generation to the next. Many similarities exist between the private annuity and an installment sale. However, the private annuity can avoid triggering a taxable event if the related party obligor decides to sell the property.
? Reverse Exchange. This is another planning tool that allows the replacement property to be acquired prior to closing the relinquished property. Recent tax rulings have blessed this strategy, but it is best to work with an experienced accommodator. In some circumstances related entities can be useful in completing a qualified exchange.
? Exchange with Tenants in Common (TIC). Often, this will be an exchange in which management-weary owners acquire a tenancy in a larger property with professional management. This is also a strategy in which related entities (i.e. a family trust or a corporation) can each acquire a portion of the equity in a replacement property. Related party rules would apply in this scenario, requiring that the related entity must not dispose of the property for 24 months.
? UPREIT. This is an exchange in which equity in a property or portfolio of properties is relinquished for shares in a REIT. This usually applies to larger and newer properties that would fit a REIT acquisition profile. Limitations apply to the sale of the newly acquired stock.
? Corporate Conversion to REIT. In June 2001, the IRS issued Revenue Ruling 2001-29 in which corporate-owned real estate can be transferred tax free to a corporate shareholder's stand-alone, business subsidiary. The subsidiary can then elect to be treated as a real estate investment trust and lease the property back to the corporation in an arms-length transaction.
? Off-Shore Trusts. This vehicle, and their distant cousin, off-shore enterprise zones, can offer special benefits under some circumstances. Consult a very specialized tax attorney or CPA to navigate these balmy safe havens.
? Redevelopment Area Joint Venture. Owners of property in a redevelopment area may find benefits in structuring a joint venture with a reliable development firm. Care should be taken to preserve long term capital gains treatment.
? Combine IRC 1031 and 121. This is a new Revenue Procedure as of February 14, 2005. When a seller has owned and lived in a home 2 out of the last 5 years, he is eligible for the capital gain exclusion under IRC 121, even if it is presently being used as a rental.
New legislation and innovative estate planning alternatives are changing the strategic landscape rapidly. While the above information offers diverse options for 2005, it is always recommended that professional counsel be consulted.
Chuck Wise, CCIM, is President of Wise Investment Properties, Inc. in Encinitas and Sr. Vice President of GVA IPC Commercial Real Estate in Carlsbad. He has specialized in investment real estate since 1971. Contact www.wiseinvestments.net for further information.
You may also contact Paul Gorman, GVA IPC Commercial Real Estate, (760) 496-1552 for more information.
While most investors are reasonably clear on the benefits of owning income property, the rarity of investors who have developed an "end-game" strategy, future plans for the timely disposition of assets under the most favorable circumstances, is surprising. Many investors have found that their net asset values have grown far beyond estate tax exemptions, and are now subject to substantial taxes upon final disposition to heirs.
In developing a plan for the settling of assets, it is a good idea to first decide which investment traits you exhibit. Most individual investors fall into one of three distinct groups: The Ostrich, the personnot interested in going much farther than having a will and, perhaps, a living trust to hold their assets; the Blue Jay, the person interested in keeping (or spending) all they have in one lifetime; and the Owl (as in wise ol'), the person that takes a long term visionary approach, and is very pro-active about their investment real estate portfolio
Even in light of such vast financial differences, each investor type can benefit greatly from keeping abreast of market trends and estate planning tools. Here are a few options available to the real estate investor who wants to cash out of real estate with the greatest amount of after tax dollars:
? Tax-Friendly Entities. First and foremost, work with a professional in both tax law and accounting to determine your best options for holding title to your property. Choosing the right form of holding title delivers protection of equity, tax savings and flexibility in planning future benefits.
? 1031 Exchange. This tool is the most popular way to put off the tax man for another day. While most 1031 exchanges are designed to defer all the gain, some are also useful in planning a graceful exit from ownership.
? Installment Sale. When a property is settled and at least one payment is to be received after the close of the taxable year in which the sale occurs, the seller will recognize gain or profit as he actually receives the proceeds, over time.
? Lease Option. Under the lease option, the title to the property remains with the taxpayer, and a contract to sell is contained in an option. The owner of the option leases the property with the lease payment equal to the amount of interest on an installment sale.
? Exchange for NNN and Sell Cash Flows. Turn a 1031 exchange into a quality net leased investment, and borrow against the cash flows at a reasonable discount. The benefits are tax-free cash.
? Family Limited Partnerships. The formation of a family limited partnership provides a convenient way of passing on equity interests to family members at bargain basement prices. Control of the property remains with the grantor or general partner and the limited partnership interests are discounted up to 40 percent.
? Charitable Remainder Unitrust (CRUT). These are especially useful when property is fully depreciated. The transfer of ownership to a qualified charity results in no capital gains tax upon sale and cash flow for the life of the donors. The charity receives the remainder of the asset.
? Retained Life Estate. The donor receives a significant tax write off in the year of transfer, and use of the property for life.
? Family Foundation. This vehicle provides involvement in funding charitable activities and specific needs, while providing tax benefits and control.
? Private Annuity Trust. Private annuities can provide significant benefits in transferring ownership of assets from one generation to the next. Many similarities exist between the private annuity and an installment sale. However, the private annuity can avoid triggering a taxable event if the related party obligor decides to sell the property.
? Reverse Exchange. This is another planning tool that allows the replacement property to be acquired prior to closing the relinquished property. Recent tax rulings have blessed this strategy, but it is best to work with an experienced accommodator. In some circumstances related entities can be useful in completing a qualified exchange.
? Exchange with Tenants in Common (TIC). Often, this will be an exchange in which management-weary owners acquire a tenancy in a larger property with professional management. This is also a strategy in which related entities (i.e. a family trust or a corporation) can each acquire a portion of the equity in a replacement property. Related party rules would apply in this scenario, requiring that the related entity must not dispose of the property for 24 months.
? UPREIT. This is an exchange in which equity in a property or portfolio of properties is relinquished for shares in a REIT. This usually applies to larger and newer properties that would fit a REIT acquisition profile. Limitations apply to the sale of the newly acquired stock.
? Corporate Conversion to REIT. In June 2001, the IRS issued Revenue Ruling 2001-29 in which corporate-owned real estate can be transferred tax free to a corporate shareholder's stand-alone, business subsidiary. The subsidiary can then elect to be treated as a real estate investment trust and lease the property back to the corporation in an arms-length transaction.
? Off-Shore Trusts. This vehicle, and their distant cousin, off-shore enterprise zones, can offer special benefits under some circumstances. Consult a very specialized tax attorney or CPA to navigate these balmy safe havens.
? Redevelopment Area Joint Venture. Owners of property in a redevelopment area may find benefits in structuring a joint venture with a reliable development firm. Care should be taken to preserve long term capital gains treatment.
? Combine IRC 1031 and 121. This is a new Revenue Procedure as of February 14, 2005. When a seller has owned and lived in a home 2 out of the last 5 years, he is eligible for the capital gain exclusion under IRC 121, even if it is presently being used as a rental.
New legislation and innovative estate planning alternatives are changing the strategic landscape rapidly. While the above information offers diverse options for 2005, it is always recommended that professional counsel be consulted.
Chuck Wise, CCIM, is President of Wise Investment Properties, Inc. in Encinitas and Sr. Vice President of GVA IPC Commercial Real Estate in Carlsbad. He has specialized in investment real estate since 1971. Contact www.wiseinvestments.net for further information.
You may also contact Paul Gorman, GVA IPC Commercial Real Estate, (760) 496-1552 for more information.