Real Estate Tax Deferral Strategies

The Ivy Group - Tax Deferral StrategiesSellers of highly appreciated property can choose from a variety of tax strategies designed to defer or cut capital gains taxes.

Below are some options:


STRATEGY HOW IT WORKS COMMENT
1031 Exchange The 1031 Exchange strategy allows a seller to defer capital gains taxes by selling a property and quickly buying another property of equal or greater value. 1031 Exchanges have grown extremely popular but they only work for commercial or investments properties. There are strict rules and deadlines. See details below.
Charitable Remainder Trust (CRT) In a CRT, a taxpayer put assets into a trust and receive regular payment streams. At the end of the trust's term, what's left goes to a charity for which the taxpayer receive an upfront tax deduction. This safe strategy can reduce capital gains, income and estate taxes. See details below.
PRIVATE ANNUITY TRUST (PAT) In a private annuity trust, assets are sold to a trust in exchange for annuity payments that last the rest of the taxpayer's life. Whatever's left in the trust when the taxpayer dies goes to the heirs free of estate taxes. A PAT allows a taxpayer to defer capital gains taxes and reduce estate taxes. But the widely promoted tactic is controversial and many critics say some arrangementss might not pass IRS guidelines. As always, professional guidance is recommended.
Structured Sale In a structured sale, a seller accepts a series of payments for the property, thereby spreading out capital gains taxes over years. The buyer does not make the payments directly to the seller but instead makes the payments to a financial services firm that issues the payment to the seller. Structured sales are a new twist on the traditional installment sales and have only just begun to gain market attraction. In a traditional installment sale, the buyer could default on payments, which is unlikely to happen with a financial services firm.


1031 Exchange Details1031 EXCHANGE DETAILS
A 1031 Exchange allows investors to defer the payment of capital gains taxes when selling an investment property and exchanging into another like-kind investment property. Strict legal requirements of Section 1031 of the Internal Revenue Code must be adhered to. There are four basic requirements when entering into a exchange. Investors should seek professional advice to ensure a successful exchange.

RULE DESCRIPTION
Property Qualifications Properties involved in a 1031 Exchange must be held for productive use in trade or business or for investment, and they must be "like-kind".
Timeline Investors must complete a 1031 Exchange within 180 days. The timeline begins upon close of escrow (COE) of the relinquished property. The new property (or multiple properties) must be acquired on or before midnight of the 180th day. Additionally, investors are required to identify potential replacement properties by midnight of the 45th day of the exchange.
Indentification All potential replacement properties must be identified on or before day 45 of the exchange. Identification must be in writing and the description of the properties must be unambiguous. There are two rules for identifying replacement properties:

1031 Exchange - The 3 Property RuleThe 3 Property Rule: Allows for identification of any three properties, of any price, anywhere in the U.S.

1031 Exchange - The 200% RuleThe 200% Rule: This is an optional rule for identifying more than three properties. Four or more properties can be identified. However, the combined value of all properties cannot exceed 200% of the appreciated property.
Tax Deferral To defer 100% of the capital gains taxes, two requirements must be met:

All the cash that was generated from the sale of the relinquished property must be reinvested All the cash that was generated from the sale of the relinquished property must be reinvested

The value of replacement properties must be equal to or greater than the appreciated property The value of replacement properties must be equal to or greater than the appreciated property


CHARITABLE REMAINDER TRUSTS (CRT) DETAILSCHARITABLE REMAINDER TRUSTS (CRT) DETAILS
A CRT permanently defers, thus eliminating, any capital gains taxes from the sale of an appreciated property.

A CRT is a valuable income and estate planning tool for selling a highly appreciated property.

To create a CRT, investors must complete the following four steps:

STEP DESCRIPTION
1 Transfer the appreciated property to a CRT.
2 The CRT sells the appreciated property and reinvests the proceeds.
3 The CRT pays an annual income to the taxpayer(s) for their lifetime(s).
4 Upon death of the taxpayer(s), the remaining assets inside the CRT are transferred to a charity or charities.


Benefits of a CRT
A CRT provides lifetime income potential, creates a charitable deduction for the taxpayer, eliminates capital gains taxes from the sale of the appreciated property, and eliminates the property from estate tax consideration.

BENEFIT DESCRIPTION
1 When the appreciated property is transferred to a CRT, an income tax deduction is created. The itemized deduction may help taxpayers pay less federal and state income taxes.
2 Elimination of all capital gains taxes on the sale of the appreciated property. After the appreciated property is transferred to the CRT, the property is sold without any capital gains taxes. The proceeds of the sale are invested and designed to provide the investor with a lifetime income.
3 The CRT is required to provide lifetime income to the investor through a Charitable Remainder Annuity Trust (CRAT) or Charitable Remainder Unitrust (CRUT).
4 At the time of death, the income payments to the investor ceases. The amount remaining in the CRT is transferred tax-free to a charity. The assets are no longer part of the investor's estate and therefore free of estate taxes.


Other CRT Considerations
A CRT is an irrevocable trust. Once the property is transferred to a CRT, the taxpayer no longer owns the appreciated property. Upon death, the remaining investments in the trust go to a charity and not to the heirs.


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