Can the Deferred Sales Trust Help Partners Wind Up Their Partnership in Real Estate Ownership?

It is not uncommon for friends or family members to pool their resources together to invest in Real Estate.  Often times they employ a strategy where they systematically use a vehicle known as a 1031 exchange to reinvest in more valuable properties using tax deferral to allow their assets to grow more quickly.

As with most such partnerships there comes a time when individual partners want to exit from the partnership or go a different direction with their investments.  Some for example may be at a stage of life where they wish to maximize their income, while others may still be in growth mode and are more interested in appreciation than current cash flow.

Here is a case study of clients I have had the honor of working with recently.

First, we have Joe, a 40-year-old widowed father of 3 elementary to middle-school-age children, and Henry, a 72-year-old divorced man with 4 adult children.

Joe and Henry decided to pool their resources a little over 10 years ago to purchase a condo for investment.  Over the past 10 years, they have exchanged twice and now own an 8 unit apartment building, which they are now thinking of selling.  Joe has a good job and is still looking to grow his real estate holdings to provide him with extra passive income at retirement. Henry at age 72 is now more interested in having more cash flow and liquidity to travel and to help his children financially.  The total capital gain on the sale of their property would be $1,000,000. Neither wants to pay taxes on that right now and while Henry would like more liquidity and cash flow, Joe would like to continue to invest in real estate and have more say and control over his investments. 

After some investigation and analysis, we determined that Joe and Henry own the property together as individuals and as tenants in common. (*)  This means that either party could conceivably enter into a 1031 exchange with their share of the sales proceeds and the other party would not have to be a part of the exchange and reinvestment into more Real Estate. (**)

Using the Deferred Sales Trust for Henry and a 1031 exchange for Joe helps them both to achieve their individual goals and to amicably wind up their investment partnership.  By using the Deferred Sales Trust as the vehicle for Henry to sell his interest in the property, he is able to defer the taxes he would otherwise have to pay, have his proceeds reinvested in more liquid and diversified assets, and generate consistent income for himself.   He also feels more comfortable in the knowledge that in case of emergency, liquidity is available that could be provided to him in a matter of days. Joe, on the other hand, can continue his investments in Real Estate on his own. For what it’s worth, Joe has the option to reinvest in Real Estate through a 1031 exchange or he could reinvest in Real Estate through the use of his own Deferred Sales Trust.   For Joe, he also liked having the option of using the Deferred Sales Trust in the event he cannot find a suitable replacement property within his 45 day time limit, which would give him an open-ended time period to find the right investment opportunity and not just have to settle for what might be available inside of his 45 day identification period.

(*) Tenant in common ownership is a type of ownership in an undivided interest in the property by two or more parties.  Each party has the right to alienate or transfer the ownership of his or her interest, including the ability to pass their ownership interest to their living heirs.

(**)   In the event Joe and Henry held title through an LLC, or general or limited partnership, the ability for either of them to do a 1031 exchange without the other would be severely curtailed, however, the Deferred Sales Trust could still be used to help each partner achieve separate goals.