Owning investment real estate is a risky proposition. While it has long been one of the most reliable ways to make a substantial profit in a relatively short period of time, that very profit can cause problems when you sell.
Your selling options generally consist of the following:
- Outright sale
- Conventional installment sale
- 1031 exchange
- Deferred Installment Sale (DST)
All but the last option creates a situation with more potential risks than you faced during the years in which you owned and likely managed the property.
Selling a highly appreciated piece of investment real estate outright creates a capital gains event. Today, the top federal long term capital gains rate is 20%. However, when you add in the 3.8% surtax that high-income investors pay, plus your state income tax, which could be as high as 13.3%, you could find yourself paying up to 37.1% in capital gains taxes. In addition, your sale could easily push you into a higher income tax bracket
Conventional Installment Sale
Section 453 of the Internal Revenue Code allows you to defer your capital gains taxes by means of an installment sale. While this minimizes your capital gains tax risk, it also creates new risks of continued ownership, including the following:
- The real estate itself serves as your only collateral.
- You become your own financing agent.
- You put yourself at the buyer’s mercy in terms of his or her default, refinancing or insistence on changing the installment note terms.
- A default or refinance subjects you to immediate recognition of all capital gains taxes due on the installment sale’s balance.
The main problem with a 1031 exchange is that it doesn’t truly sell your real estate in terms of allowing you to exit the real estate investment market. Instead, it simply exchanges the property you now own for like-kind property. In addition, a 1031 exchange subjects you to stringent time lines. First, you must designate potential replacement properties within 45 days of relinquishing your property. Then you must complete the exchange within an additional 135 days since you have only 180 days total between your relinquishment date and the date of your acquisition of the exchange property. If you miss either of these deadlines, the entire 1031 exchange fails and you face immediate capital gains recognition on your full sales profit.
A Deferred Sales Trust (DST) solves all of the above problems and eliminates your ownership risks associated with them. The DST is a proprietary installment sale tax strategy offered only by the Estate Planning Team.
To utilize this unique tax strategy, you and your real estate broker initially proceed as though you were going to do an outright sale. Rather than consummating the sale, however, you meet with the Estate Planning Team to discuss your sales objectives, as well as your overall investment goals, your risk tolerance and your income needs and desires. The Team’s tax attorney then draws up your personalized DST.
You sell your property to the DST in exchange for a secured installment contract. Your Independent Certified Trustee then sells the property to your designated buyer for the same amount and begins making payments to you in accordance with the contract.
Your freedom from ownership risk thus makes the DST the perfect exit strategy, not only for real estate, but also for any other type of investment. In addition, the DST is a great 1031 exchange alternative and can even rescue you from a failed 1031.
Contact Reef Point today to see how the DST can legally and safely defer your capital gains taxes while eliminating your risk of ownership.