As I have mentioned in previous blog articles, our Section 453 proprietary trust is a better option to defer taxes than a 1031. I am not going to rehash all the advantages of our trust over a 1031 but am going to discuss some opportunities to get listings because our trust is far more flexible than a 1031. I will put on my John Wayne cowboy hat and ride to the rescue again with some 453 selling opportunities.
First, today there is cheap money so why not take advantage of it while cheap money still exists. When transacting a 1031, you must use your proceeds to buy that replacement property. If you want to downsize, you may have a taxable event. Instead, let Section 453 come to the rescue. Of course, you would need to look at the numbers, but this could work. Sell the property and use our proprietary trust instead and here’s why. When the sales proceeds go to our trust, they can be invested in several diversified investments. We will normally invest conservatively to generate a 5-6% cash flow and that can be paid to the seller on a monthly basis. As an example, say $1 million at closing goes into our trust and is invested to generate a 6% cash flow or $60k a year paid in monthly payments of $5k.
Now if you can borrow at 3%, wouldn’t it make sense to borrow at 3% when the trust is generating income at 6%? Absolutely so it’s possible that the trust income can be more than enough to pay the monthly debt service on the new property. And best of all, no 1031 requirements. At some point, the property is paid for and the trust is still generating a monthly income.
This probably never happens but every blue moon, a seller may think that his property is worth more than the market does. Because the property is not being offered at a reasonable price, no offers are coming in. If you lowered the price even a little, buyers would be fighting over the property, but the seller is being stubborn and won’t budge. Try this.
Tell him that if he lowers his selling price, he can net more sales proceeds. Say that he wants to sell at $10 million and has a $2 million tax liability so he will net $8 million if anyone will give him $10 million.
Instead, tell him that he can lower his price to $9 million and that you can defer his $2 million tax liability so he will gross and net $9 million. If he wants to retire, he can do so with a larger lifetime retirement income or he can go buy more property possibly using the first idea above. He controls his own situation.
This absolutely never happens but just in case. 20 years ago, 2 good friends decided to buy a property together. Every time, one of the partners wants to do something to the property, the other partner says no, and this happens all the time. Now their property is worth a lot of money, and they are going to pay a lot in taxes if they sell. A 1031 is completely out of the question because they are at the point where they cannot stand each other, and the only remaining question is who is going to murder the other partners. Think of the O’Hara brothers in “The Gal Who Took Over the West.” But worse. Keep them both alive. Each of them can set up their own 453 trust, the proceeds go into each separately, they invest separately and never have to see each other again. You just made a sale you might not have otherwise and saved 2 lives at the same time.
In a slightly different scenario, a property has 4 owners and want to sell. The problem is that the 2 older partners want to sell and defer taxes and the 2 younger partners want to sell, pay taxes and head to Vegas. Not necessarily a bad strategy. It’s a great property and will sell quickly. They want you to have the listing but first, you must get everyone on the same page. So, guess what you do. You pull out your listing agreement and show everyone where to sign and then you tell them that each partner can do as they please. The 2 older partners can use the 453 trust to defer taxes and the younger partners can take the money and run to Vegas on one condition…they take me with them. You just solved a problem that very few brokers could have solved.
We have all heard the comment, “don’t put all of your eggs in one basket.” When transacting a 1031, that is exactly what you are doing. There is a better way. When using our 453 trust, the sales proceeds can be invested into several asset classifications. Those asset classifications can be stocks, bonds, fixed income, real estate investment trusts, guaranteed insurance contracts and much more and we can actively manage that portfolio to possibly reduce investment risk. If the opportunity to buy more real estate presents itself, you can use some of the trust assets unless there is still cheap money available. You keep all your eggs in our trust not a basket.
One of the big problems with a 1031 is that you must make decision at closings that could affect you for years. What if instead, you could make decisions in “real time”? With 453 you can. For example, sell your property today and have an unlimited time to buy more real estate. You buy on your time schedule not the Internal Revenue Service’s timeline. If you want to buy another property but later decide not to, you can still use the trust income as a retirement plan. Again, because we have no 1031 requirements, you can make decisions in “real time” and not “IRS time.” Also, you can pay taxes on your time and not the IRS’s time.
Quite often, landowners may get a little confused on their cost basis. For example, say someone has been transacting 1031s for a couple of decades and now they want to sell their property and pay taxes. Many times, the property owner believes that their basis for tax purposes is the basis of the last property they bought when in fact, their basis for tax purposes is the basis of the first property they bought. When you exit a 1031, you have an immediate taxable event but with 453 you don’t. When you sell a 1031 property and the proceeds go into the 453 trust, that is a 1031 exit strategy. Instead of having an immediate taxable event, what is happening is as follows. The sales proceeds are deferred for as long as the seller would like. Uncle Sam is giving the seller what amounts to an interest free loan with no repayment schedule and the seller now can generate a nice return off that loan.
If you want to generate an income from the interest free loan, ie, the tax deferral, you can for 10, 20, 30 years or longer. And the tax deferral and income generated from the tax deferral can be passed on to your heirs. As mentioned earlier, you can decide when to pay those taxes in “real time” and not on “IRS time.”
One other quick opportunity. Say someone is selling a legacy property, 453 can take that legacy property out of the family’s estate which could reduce a family’s federal estate tax burden. A 1031 cannot.
There are a number of other opportunities that we can discuss but I believe that I hear Nell Fenwick, Dudley Do-Right’s love interest being tied to the railroad tracks again by Snidely Whiplash so I need to go save her, again. I will be back, and we can discuss more great opportunities for you and your sellers using 453 rather than a 1031. Happy Selling.
by David Fisher
David Fisher is the founding partner for Creative Real Estate Strategies, a firm dedicated to helping their clients buy and sell real estate in the most tax efficient manner through cost segregation, tax credits or deferring taxes through our Section 453 proprietary program.