Strategies for Sellers to Defer Capital Gains Taxes
1031 Exchanges, Delaware Statutory Trusts & Opportunity Zones
Presented by The Skinner Team |KW Top of The Rockies
This information may be advantageous for you when it comes time to sell your investment property. Each of these strategies outlined below can be great options to defer or potentially dissolve the capital gains tax you might incur from selling a property. A 1031 is the most common thing sellers do to help defer capital gains, however, there are two additional options within a 1031 that are not widely known but are also excellent strategies you may want to consider.
IRC Section 1031
Section 1031 of the Internal Revenue Code (IRC) allows a taxpayer who owns property held for investment or used in a business to sell a property and defer paying capital gain taxes and depreciation recapture taxes if the taxpayer purchases a “like-kind” replacement property.
What are the benefits of a1031 exchange?
A 1031 exchange can be a great tool if the owner wants to:
- leverage into a more valuable property
- purchase a property with better cash flow
- diversify into other properties
- consolidate into one larger replacement property
What is like-kind property?
Like-kind property can include, but is not limited to, virtually any type of real property, provided it is held for investment or used as a business:
- single-family long term or short term rental
- multifamily rentals
- industrial or commercial property
- land
How much time do I have to execute a 1031 exchange?
Timelines become important went executing a 1031 exchange
- Taxpayers must identify the potential replacement properties (usually 3 although in some situations it may be more) within 45 days from closing on the sale of the relinquished property
- Taxpayers have 180 days between the sale of the relinquished property and the closing of one of the identified replacement properties
Keep in mind, paramount to any exchange is a competent and experienced qualified intermediary. Not following the proper rules or not using a qualified intermediary can invalidate an exchange. You will need to have your intermediary lined up before you sell!
For more information on 1031 Exchanges:
- https://www.irs.gov/pub/irs-news/fs-08-18.pdf
- Exchange Basics – Asset Preservation, Inc. (apiexchange.com)
Delaware Statutory Trust
One option within a 1031, especially if you no longer wish to be a landlord or are unable to find a suitable replacement property, is to do a 1031 exchange into a Delaware Statutory Trust (DST). You would need to identify a trust as one of your replacement options and then you would move your funds into the trust of your choice.
What is a DST and who can utilize it?
A DST is a type of trust formed under Delaware law. A DST allows investors to own undivided fractional ownership interests in professionally managed institutional grade real estate offerings around the United States. A DST creates an indirect way of owning investment real estate.
The types of real estate owned by a DST may include:
- Class A multi-family apartments
- Medical buildings or Hospitals
- Distribution centers
- Manufactured home communities
- Senior Living
- Student Living
- Storage portfolios
What are the advantages of DSTs?
- Smaller minimum investment and access to ownership of high-grade commercial properties that would be otherwise difficult to acquire individually
- Passive ownership with no day-to-day headaches of typical real estate ownership
- The trust is not considered a taxable entity and, therefore, all the profits, losses, etc. are passed through directly to the investors
- Investors participate in depreciation and amortization in the same way an investor who owned a 100% ownership interest in his or her own real property would
- Can be utilized on your list of 1031 identified properties as a backup to ensure all the proceeds from the sale of the relinquished property achieve full tax deferral
For more information on Delaware Statutory Trusts:
https://apiexchange.com/delaware-statutory-trust-dst/
The top 10 reasons investors are jumping into DSTs:
Opportunity Zone Investments
A further option is to invest into an opportunity zone. An opportunity zone essentially lets you dissolve most or sometimes even all of your capital gains. There are two ways to accomplish this, either purchase a property in an opportunity zone or buy into a DST type fund that owns in opportunity zones.
What is an Opportunity Zone?
The federal government designates some disadvantaged communities as opportunity zones. Through the 2017 Tax Cuts and Jobs Act, opportunity zone tax benefits were created. The goal of these incentives is to encourage long-term investments in low-income neighborhoods through private investment. With these tax incentives in place, the federal government hopes to create an opportunity for investors while pushing more possibilities into disadvantaged communities. Through opportunity zones and opportunity funds, which are the investment vehicle, investors can take advantage of tax benefits as a reward for tackling investments in low-income neighborhoods.
What are the benefits of Opportunity Zones?
- Tax deferral from capital gains taxes
- Investors who chooses to invest in an opportunity fund will receive a 10% step-up basis after 5 years of investing in the fund before 2026***
- After 10 years, tax deferred becomes tax free, creating a great option for long-term investors***
- There are over 8,000 Opportunity Zones (however, it’s important to do your research on which makes the most sense for you)
- You have the have the opportunity to purchase either a property directly in a qualified Opportunity Zone or purchase into a Opportunity Zone Fund (much like a DST)
*** Maximum benefits will be determined based on when you purchase into an opportunity zone.
Learn more about opportunity zones:
- https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions
- https://oedit.colorado.gov/colorado-opportunity-zone-program
- https://www.rocketmortgage.com/learn/opportunity-zones-tax-benefits
Are opportunity zones for you? 5 Questions to ask yourself:
Are Opportunity Zones for You? 5 Questions to Ask | Kiplinger
Don’t hesitate to reach out if you have any questions!
