In my humble opinion, real estate is a much better investment than the stock market. One of the reasons has much to do with taxation. A wise man once said, “It is not how much you make, but how much you keep.” This phrase is very true and therefore, I would like to introduce you to a way that you can buy and sell real estate, without ever having to pay capital gains taxes, yet still utilize the profits!
Currently, the capital gains tax on investments held for less than 12 months can be as much as 50%! Ouch, over half of your gains headed right to Uncle Sam! However, if you have lived in a property as your primary residence, and claimed such on your tax returns, for a total of two years over the last five year period, you can claim an exemption on those gains up to $250,000 filing single, and $500,000 married filing jointly. That is a half million dollars of capital gains, tax free, every two years, married filing jointly!
OK, that takes care of your primary residence,but real estate investors typicallydo not live in their investment properties. Therefore, they are subject to the higher capital gains tax….unless….you perform a 1031 Exchange.
Many of you have most likely heard of a 1031 exchange, however, when introduced to this IRS code by an amateur, the rules and procedures can seem too daunting to take advantage of. Not the case. A 1031 exchange, also known as a Starker exchange or a tax-deferred exchange, allows investment real estate proprietors to sell real estate and set back tax payments by reinvesting the payoff into a like-kind investment place or properties. It is granted by Section 1031 in the Internal Revenue Code.
So how does this work? Let’s say you own a property that you want to sell, for various reasons. You can sell that property, place the profits of that sale into an intermediary’s account, locate another “like-kind” property within 45 days and close on the new property within 180 days. By doing so, you take all of the proceeds from the sale, and leverage the new real estate with them, all the while deferring the capital gains tax!
I highly recommend that you use an intermediary that specializes in this type of transaction as they will make sure the proper forms, time-lines, and rules are met in order to safeguard the use of the 1031 exchange. Their fees are nominal, and it takes the risk off of messing something up so that you did not qualify. I can point you in the right direction for hiring an intermediary as I have used several different ones over the years.
Now, deferment of taxes can only go so far. Many moons down the road, after you have established your real estate empire, you may want to “cash-out” of the business and sail around the world. At this point, selling all of your real estate holdings and realizing the profits may send an armored car to your door. The backing up of the Brinks truck to haul away your taxes owed may be the first thing you hear in the morning. However, there is another little tool that can be utilized, and you can become a hero to your community at the same time!
In comes the Charitable Remainder Trust! A Charitable Remainder Trust, also known as a CRT, is an irrevocable trust designed to convert an investor’s highly appreciated assets into a lifetime income stream without generating estate and capital gains taxes. CRT’s have become very popular in recent years because they not only represent a valuable tax-advantaged investment, but also enable you to provide a gift to one or more charities that have special meaning to you. A CRT can potentially:
- Eliminate immediate capital gains taxes on the sale of appreciated assets, such as stocks, bonds, real estate and just about any other asset.
- Reduce estate taxes of up to 55% that your heirs might have to pay upon your death.
- Reduce current income taxes with a sizable income tax deduction.
- Increase your spendable income throughout the rest of your life.
- Create a significant Charitable Gift.
- Avoid probate and maximize the assets your family will receive after your death.
When you establish a CRT, you or another beneficiary, such as your spouse or another family member, receive income from the trust for life or for a term of up to 20 years. When the trust ends, the remaining assets pass to the qualified charity or charities of your choice.
So there is it, your blue print to beating the tax system when investing in real estate. Now, I AM NOT a certified public accountant, tax advisor, or financial advisor and I recommend that you confirm that this will work with your particular situation, but I would bet that it will!
So contact me for more information, referrals to local professionals that are familiar with these products, and let’s get shopping. With any investment, buying low and selling high is the name of the game. With property values down and interest rates below what I ever thought could be realized, there is no better time to play Monopoly in real life!