In the midst of these uncertain and unstable financial times, it’s all the more crucial to understand your options as you think about selling a business or income-producing real estate.
Depending on the value of your asset, you could save hundreds of thousands of dollars using legal strategies that allow you defer the capital gains tax on the proceeds from the sale. That doesn’t mean you no longer have the tax liability, but it puts you in the driver’s seat to determine when you pay the tax and how much. The best part is, you can put your money back to work for you, to create more income and growth.
One such strategy is a 721 Exchange. This comes right out of the IRS tax code and is also referred to as an Umbrella Partnership Real Estate Investment Trust. Setting up an UPREIT isn’t overly complex, but it does call for an experienced team of professionals to do it correctly.
The following is based on a true story that illustrates how a 721 Exchange works and some of the benefits of the strategy.
Jeff had held onto his family farm for many years. While the farm was worth about $1.2 million, it wasn’t generating adequate income or growth for Jeff to be in a good position to retire comfortably. He did the right thing: He sought the advice of his trusted financial advisor. Jeff was advised to sell his farm through a 721 Exchange, defer the capital gains tax and recapture the tax bill through tax advantaged income and growth. The 721 Exchange would give Jeff the benefits of participating in real estate from a passive position, so he could relax and enjoy his retirement.
In simple terms, here’s how it works. Jeff formed a partnership with a local Real Estate Investment Trust company, which became the managing partner. The farm was then sold by the partnership and, in exchange for the $1.2 million sale price of the farm, Jeff received $1.2 million in “operating units” in a Real Estate Investment Trust (REIT) fund. This strategy enabled him to defer the $250,000 capital gains and invest the entire $1.2 million in the REIT. With the REIT producing over 6% annually in dividends, Jeff was paid a quarterly dividend and was able to take advantage of an accelerated 12-year depreciation schedule on the property.
All of this added up to a very tax friendly annual income for Jeff — three times more than what he had been getting off the farm. As a part owner of the multi-family property held by the REIT, Jeff will participate in the overall growth of the property’s value over time in proportion to the amount of his ownership interest.
What if Jeff has some unforeseen event where he needs access to his money? The 721 Exchange allows for liquidity. If he needs to, Jeff can convert a portion of his operating units, selling them at the current market value. At that time, he will be liable for the capital gains tax on the portion that he cashes out. Looking to the future to his heirs, Jeff’s shares in the REIT can easily be designated to multiple beneficiaries.
If this story resonates with your own situation, there are resources available. Equilus Capital Partners, a real estate investment trust company, specializes in tax deferral strategies. Our team of professionals is experienced in executing 721 Exchanges as well as other kinds of tax deferral strategies. Don’t hesitate to contact us at (509) 665-8349, and find out if we have a strategy that’s right for you. The initial consultation is complimentary.