Someone much smarter than me once said that businesses that do not evolve are sure to get left behind. Who knew that he was talking about AOA members. That’s right. Here’s why.
When an apartment owner decides to sell and wants to defer taxes, they think of a 1031. But in a 1031, you may be able to sell in a sellers’ market but then may have to buy in a sellers’ market. That makes no sense. If he wants to sell and retire and doesn’t want more real estate, he pays taxes. If there is more than one property owner and if they are not all on the same page to defer taxes, a 1031 won’t work.
A 1031 is like an iceberg. You see the 10% of what works but not the 90% that is under water, so to speak, where they don’t work. In our program, you see 10% of the solution but not the other 90% of what you can do to keep more money in your pockets.
Good thing the DST can come to the rescue. Just like John Wayne did in the old west when he saved Shinbone from Liberty Valance and like when he won the Civil War and WW2. However instead of using a gun, we will be using the next generation of 1031s – the Deferred Sales Trust.
Deferred Sales Trust
You may not have ever heard of the real DST but that’s ok. Again, remember that this DST is the Deferred Sales Trust and not the other DST, Delaware Statutory Trust. They are two completely separate programs. The Deferred Sales Trust is a proprietary trust based on Section 453 of the tax code and has a 30-year track of successfully deferring taxes over 3000 times. If you ask your CPA or attorney about it, there’s a high probability that he or she has never heard of it so they will say something negative like the trust is a scam or an abusive tax scheme.
Here is the bottom line. Regardless of what anyone else says about it, the IRS has no problems with it, and they are the final say. That’s right. The IRS has done 12 audits with the largest audit being on the sale of a $130 million property with a $50 million tax deferral. They came in, did their audit and left with a “no change” letter meaning they found no problems with the trust. That happened every tax audit.
In 2019, the IRS did another audit on all the trust documents, supporting documents and anything else they thought was appropriate. They sat down with our tax attorneys in Los Angeles, and they had no problems with anything that they saw. The bottom line is that regardless of what anyone says, the trust is on solid legal and tax footing. Game. Set. Match.
You Have Choices
Now … let’s get down to opportunities. Apartment owners are being attacked from all sides from Sacramento by clueless politicians and all of you know that better than I do. Some of you may want to get out of real estate for the near future and some of you may want to get out and move to a lower-taxed state. If you like high humidity, high heat and hurricanes, Texas and Florida have plenty of room for you. If you like cold weather, move to Iceland and don’t tell anyone.
What if you can sell today, defer the capital gains tax, state tax, depreciation recapture and the Medicare tax and have an unlimited amount of time to buy another property when the market is more favorable to buyers? A 1031 can’t. A DST can. And, it can generate about a 5% conservative rate of return on the sales proceeds in the trust whether you want more real estate or want to retire.
What if depreciation plays a big role in your property? When you transact a 1031, you do not get a new depreciation schedule on the replacement property. You may get a partial schedule but not a new one. But with a DST, you do. So, unlike a 1031, every time you buy a new property using this trust, you get a new depreciation schedule which means that you can accumulate more real estate wealth with the trust.
A Scenario
Let’s say that you own a property with two younger partners. All three of you decide that it’s a great time to sell, but that brings up a new problem. You are the older partner, and you want to sell and defer your taxes. The two younger partners don’t want to defer their taxes but rather take whatever is left after taxes and run to Vegas.
Considering the current environment, that may not be a bad strategy. In order to transact a 1031, all the partners must agree to do so and that isn’t happening, Unlike a 1031, when using this trust, each partner can make their own decisions so you can defer your taxes and you can still go to Vegas and show those young partners how it’s really done.
One of the great opportunities that this trust brings to the table is as a great 1031 exit strategy. For example, you have been transacting 1031 exchanges for several properties for many years and now you want to retire, or you want more real estate, but the timing isn’t right to buy after you sell your current property.
If you want to retire and don’t want more real estate, you may not realize that your basis for tax purposes is not the basis of your last property but rather the basis of your original property. Not good. But if you sell the last property and use this trust, you can defer those taxes for the rest of your life and the deferral can be passed on to your heirs. At some point, taxes will have to be paid but if you can leverage that tax deferral for 10, 20 or 30 years, that’s a huge opportunity.
One huge advantage that it has over a 1031 is being able to make decisions in real time. In a 1031, you basically make the decisions up front and must live with them. Maybe that’s not a bad deal.
But what if you can make decisions in real time? For example, you are using this trust and three years down the road, you suffer a large capital loss in another investment. It might be possible to offset those losses by taking some of the capital gains out of the trust and by doing so, you just took some capital gains out of the trust without paying any taxes. Works for me.
Now I recognize that this is dreaming but let’s believe that after being in the trust for seven years, we now have a Congress that understands that it’s our money not theirs. I know, but work with me here. So, they reduce the capital gains tax rate to 10%. Now it may make sense to start taking capital gains out of the trust at the lower tax rate. I am not sure that you can do that with a 1031. You can with a DST.
Let’s say that you want to transact a 1031 but it’s day 42 and nothing has been identified because you haven’t found anything that you are interested in. Would more time be helpful? Of course, it would be so here’s what you do. First, you need to work with a third party 1031 QI who knows about this. Most don’t but a few smart ones do. When your 45-day period is up, instead of the QI sending you the sales proceeds and now you have a taxable event, they will send the proceeds to a trust that has been created on your behalf and not only is there no taxable event, but you are still in the game to buy more real estate. You’re welcome.
Now let’s change our focus from buying more property to selling and retiring with no more real estate. If you don’t want more real estate, a 1031 isn’t even appropriate. Don’t let anyone sell you on the idea of a Delaware Statutory Trust. The Deferred Sales Trust makes much more sense for a variety of reasons. You can sell today, defer the capital gains tax, state tax, depreciation recapture and the Medicare tax and retire today with a larger pretax lifetime retirement income than if you paid taxes first. But just as important, again you can make decisions in real time.
Do you just want to relax and enjoy retirement? Do you want to move to a lower-taxed state? Maybe after some time away from real estate, you may want to jump back into real estate and get your toes wet again. The bottom line is that you have control over your life.
We have all heard the saying, don’t put all of your eggs in one basket. Well, unless they’re your Easter eggs. That is especially important when you want or are already retired. That’s why this trust works so well. After you’ve sold your property and deferred your taxes, it allows you to diversify your investments in your trust. Stocks? Bonds? More real estate? Guaranteed insurance contracts? Fixed income? Oil and Gas? Well, not O&G but just about any conservative investment that would be considered suitable for your risk tolerance. And you can adjust your portfolio when appropriate.
A Quick Story
Recently, I finalized my plans for my funeral. I am not planning on going anywhere at the moment, but it was the responsible thing to do. So, the saleswoman asked me how I would like to pay the expenses and I asked her what my options were. She said that I could pay a lump sum or pay it over the next couple of years. I asked her if I took a payment plan but died before I finished paying, what would happen? She smiled and said that won’t happen because we have an agreement with the Good Lord that he won’t take any of our clients until they have fully paid their expenses. I said great, I’ll take the 40-year payment plan!
Why did I mention that story which, is true, by the way. It’s because when it’s your turn to move on, the trust assets can be passed on to your heirs so they can continue to receive the benefits of the tax deferral and the income generated from the tax deferral for as long as they like. That is assuming that your funeral home doesn’t have a 40-year plan.
Closing Comments
As I mentioned in the beginning, this trust is like an iceberg. There are so many additional benefits that there isn’t enough time to mention everything here. What if you want to sell and retire and can’t come down on your $4 million sales price because of your tax liability and you have a great buyer but because of rising interest rates, he can only qualify for $3.5 million? What if you have a business to sell? What if you are selling your primary high-end residence and the sale will create a large tax liability when sold? What if you have a legacy property that will create a federal estate tax burden to your family?
The Deferred Sales Trust may be a great solution to these and many other problems that may arise when wanting to sell. Again, don’t listen to those that really don’t understand; the IRS knows all about it. I appreciate your interest and your time spent on reviewing this article.
David Fisher is the managing partner for Creative Real Estate Strategies. His national firm specializes in deferring the capital gains tax, state tax, depreciation recapture and the Medicare tax on the sale of highly appreciated assets. He has helped apartment owners all over the country defer millions of dollars in taxes. For additional information, visit www.cresdeferstaxes.com, call 713-702-6401 or email [email protected].