DON’T RUN “YOUR PROFITS” DOWN THE DRAIN !!
If you are interested in Real Estate investing or if you own directly or indirectly commercial or Multi-family income property consider this typical “Baby Boomer” hypothetical case:
Tax deferral may be critical to you
In January 1985 you bought and close on the purchase of a new 6-plex Multi-Family property for $230,000 dollars all cash or with some debt financing which is now paid off. You have rented the facility out successfully for 30 years earning an acceptable return on your invested funds since rents about kept pace with the devaluation of the dollar over this period. You have also handled all the Property Management and Maintenance issues or contracted this out.
You now want to get your cash out and enjoy life.
But how? Since significant taxes and fees could be on your horizon and you may not have done nearly as well on this investment as you thought or can.
Let’s do some calculation on how these property owners may really fair. 1985 your asset was new and worth $230,000 – what you paid for it. It’s now 30 years later and somewhat more seasoned. But if we assume its value is tied close to the U.S. Department of Labor, Bureau of Labor and Statistics Expenditure category shelter you’ll need about $700,000 today to buy that same building, or something in the range of $110,000 to $120,000 per unit.
So if, thru your investment and work have kept up with the increasing cost of goods and services and if you had $700,000 today you could buy what $230,000 would have bought you in 1985.
Your problem is now how to get as much of this $700,000 as you can; given the fees, taxes and expense you could be facing where you follow the traditional purchase and sale real estate transaction path. Fees and taxes such as:
• Realtor fees, maybe 6% of the typical facilitated Purchase and sale amount.
• Capital Gains taxes (State and Federal) & Depreciation Recapture as ordinary income and 25% tax rate.
• Affordable Care Act taxes (Obamacare Tax) at 3.8% of any gain.
• Environmental Report or modernization remodel work, if any
• Inspection repairs
• Escrow and Closing fees
• Attorney document checking
Cumulatively this can amount to in the order of a 40% disappearance of a purchase and sale amount. You get about 60 cents of the sale dollar.
One favored way to avoid this hit is do what is referred to as a 1031 Exchange which will allow you to defer some of your transaction taxes and exchange your property for another property, so long as you do not get any “boot” which you get the privilege of paying taxes on, and you will be required to comply with the IRS’s 1031 exchange regulation that are detailed and controlling. Google 1031 Exchange, under IRC Code Section 1031 and/or see URL http://www.irs.gov/uac/Like-Kind-Exchanges-Under-IRC-Code-Section-1031 for an overview or these potentially troublesome regulation which are restrictive and must be complied with, please also note the several traps and opportunities to mess up on an 1031 Exchange, which definitely, by the way, will restrict your opportunities to get cash without paying the men in black. Having a qualified intermediary is critical for a 1031 Exchange.
The prevailing idea behind the 1031 Exchange is that since the taxpayer is merely exchanging one property for another property or properties of “like-kind” there is nothing received by the taxpayer that can be used to pay taxes. In addition, the taxpayer has a continuity of investment by replacing the old property. All gain is still locked up in the exchanged property and so no gain or loss is “recognized” or claimed for income tax purposes.
In order to obtain full benefit, the replacement property must be of equal or greater value, and all of the proceeds from relinquished property must be used to acquire the replacement property. The taxpayer cannot receive the proceeds of the sale of the old property; doing so will disqualify the exchange for the portion of the sale proceeds that the taxpayer received. For this reason, exchanges are typically structured so that the taxpayer’s interest in the relinquished property is assigned to a Qualified Intermediary prior to the close of the sale. In this way, the taxpayer does not have access to or control over the funds when the sale of the property closes.
In a 1031 Exchange that you take any cash out of, for some reason this cash is called “boot” and it’s taxable. Do you ever wonder why?
Perhaps the best way is to get spendable cash from disposition of Income Property is the exchange into DST, TIC or LLC capable of lending you money where you can get the cash you want or will accept; potentially to somewhat over the limit of your estimated equity from an Income Real Estate Property after taxes and expenses.
Many owners at this stage give in and opt for a Realtor facilitated purchase and sale transaction with Taxes, Expenses and the Real Estate agent fees, and often get “helpful” guidance from your Realtor as to what the asking price of your property should be.
The Author of this “White paper” has experienced this “Independent” guidance going several ways with property owners interviewing Realtor’s. Situation #1 where the selected Realtor suggests “That he can get the highest price for the property.” Usually in the order of 5 to 15% over the other Realtor’s sale price expectation. This may or may not happen. Situation #2. Where the selected Realtor sells his or his firm’s ability to market the property and asserts he is in contact with all kinds of buyers. Situation #3. Where the Realtor sells on the capabilities and size of his Firm, or its number of Agents and the concept that “big is better.” Situation #4 where the Realtor convinces the seller that he or his firm will be comfortable, confident and trustworthy in handling the sale and will work hard to assure mutual success with the Sellers. The Author prefers the latter suggests someone do applicable local Real Estate Market Research.