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Tax Strategies for the Sale of Investment Real Estate

TAX REFORM? HARDLY. Alternative minimum tax (28%), California State income tax (9.3%), depreciation recapture (25%-28%), loss of deductions and exemptions, can add up to an effective tax of 35-40% on sale of appreciated property.

An Installment Sale spreads realization of capital gains over the installment period.  However:

  • Tax benefit may be confined only to AMT calculation.
  • Investor retains real estate risk until installment payments are completed.
  • Defers capital gains tax only until next installment payment.

A 1031 Exchange defers capital gains by exchanging your property for another investment property.

  • Replacement property must be of equal or greater value.
  • Must reinvest all equity and retain equal or greater debt ratio on replacement property.
  • Strict time limits. Must identify replacement property within 45 days, must close within 180 days.
  • Defers capital gains only until ultimate sale. Heirs may pay estate taxes.

1031 Exchange Tenant-in-Common. An accredited investor can exchange into a deeded, fractional interest of a larger institutional-quality property.

  • Relief from active management.
  • Non-recourse financing.
  • Often higher-yielding replacement.
  • Diversify geographically.
  • Consolidate many properties into single parcel.

A Tax-Exempt Trust allows the seller to cash out and avoid both capital gains tax and real estate investment risk.

  • Avoid all taxes on sale of property.
  • Sales proceeds invested, compound tax-free, similar to an IRA.
  • Diversify real estate investment into a diversified securities portfolio.
  • No real estate investment risk.
  • Income stream and tax deduction can be highly customized.
  • Remove all asset appreciation from your estate.

Early planning is critical. IRS has strict rules and time limits. Know your options before you list your property.

Summary

Installment Sale

  • Seller-financing technique.
  • Taxes deferred, not avoided.

1031 Exchange (Sole ownership)

  • Desire real estate investment.
  • Retain active property management.
  • Can be difficult finding replacement property within IRS time limits.
  • Absolutely no time extensions permitted by the IRS.
  • Taxes deferred, not avoided.

1031 Exchange Tenant-in-Common (Co-ownership)

  • Relief from active management.
  • Diversification, high quality.
  • Often higher-yielding replacement.
  • Easier to meet IRS time limits.

Tax-Exempt Trust

  • Desire to cash out of real estate.
  • Avoid all taxes on sale of property.
  • Diversification of investment.

This is not legal advice. Any prospective candidate should seek the advice of a qualified estate and/or tax professional to determine the individual consequences of a tax strategy.