Tax Strategies for Real Estate Profits

Alan Clopine, CPA, Director of Tax Consulting

The impressive gains in the real estate market in the past five years have created many new millionaires.  Virtually all property classes including multi-family, office, retail and industrial buildings have increased in value. 

Many investors are wondering how they can enjoy their real estate gains in a tax efficient manner.  Income tax rates can range from 25% to 55%, depending on long-term and short-term capital gains rates, depreciation recapture, state taxes and self-employment taxes for real estate dealers.  Estate tax rates in 2007 are currently 45% on estates over $2,000,000.

Some investors desire a lump sum of cash, while other investors prefer a steady cash flow.  Still others may wish to shelter their real estate from potentially significant estate taxes for the benefit of their beneficiaries and selected charities.

Let’s first examine a couple of ways to create a lump sum of cash.  An investor can of course sell their property and pay appropriate capital gains taxes.  While this may not be the best solution, some taxpayers have capital loss or passive loss carryovers, which will offset their taxable gains.  In some cases, an investor may simply decide to refinance their property to pull out some cash.  Generally, a cash-out refinance results in no taxation to the taxpayer, however one must be careful not to create significant negative cash flows.

For investors who would rather create a cash flow, one idea is to sell their property with an installment note, thereby deferring a portion of their capital gains.  The buyer simply makes monthly payments on the note over a negotiated term.  The deferred taxes will be payable as principal payments are received on the note.

Often an investor will be able to improve cash flows by trading into a new property under a 1031 exchange.  This popular technique allows the investor to defer some or all of their capital gains.  A 1031 exchange requires that an investor acquire a replacement property or properties of equal or greater value; identified within 45 days after the close of escrow and purchased within 180 days after the close of escrow.

A good option for many investors is an exchange into a Tenant in Common (TIC) or Delaware Statutory Trust (DST) investment, which is a part ownership in a large professionally managed property.  There are perhaps 120 different sponsors that offer these types of investments, ranging from multi-family to office to self-storage.  These investments often generate cash-on-cash returns of 6% or more.  There is also the possibility of future appreciation on the property.

Some investors may opt to simply exchange a growth property for an income property.  Perhaps a triple-net single-tenant building, in which the tenant pays all of the expenses, would be a great solution.  The investor simply sits back and collects monthly rent checks. 

Investors more concerned with estate taxes may consider contributing their appreciated property to a charitable remainder trust or charitable lead trust which can be very effective estate planning tools.  In some cases, an investor can save millions of dollars in estate taxes by utilizing trusts and other strategies.

With all the techniques available to efficiently realize profits in real estate, it’s prudent to explore options with your relationship manager at Centara.

© Centara Capital Management Group, Inc., 2007. All rights reserved.

Centara Capital Management Group, Inc.
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San Diego, CA 92108
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www.centaracapital.com
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