National Income Property works with real estate investors like you on a daily basis. Having been in the real estate “trenches” ourselves as award winning owners and operators, (our latest apartment investment won Real Estate Investor of the Year from the National Apartment Association) we understand and appreciate what it takes to acquire and manage an asset.
Most owners would agree that acquiring, owning and selling an investment property is a considerable amount of time-consuming, hard work without an immediate payoff. So when we meet investors who have investment properties and have successfully built wealth through their real estate, we always have a high level of respect for them and their accomplishments.
One question all investors should continually ask is: "What are my exit strategy options?"
The reality is, once investment real estate owners have accumulated equity in a property they have 7 options:
| 1. Keep the Property |
You can keep your property and either actively manage it or hire a management company to manage it for you. This option is the one everyone who invests in real estate knows and understands clearly. However, there usually comes a point when the owner becomes tired of the toilets, tenants and trash, and begins to look for other options to either liquidate or move into a more passive ownership position.
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| 2. Refinance and Keep the Property |
Refinancing is often a popular choice for investors because they know that it is a "tax-free" event. However advantageous it may appear on the surface, there are several factors to consider and we encourage investors to consult with professionals other than just their mortgage brokers on this option. If you have a lot of built up equity,you have an immediate need for capital, and you plan to hold the property, a refinance may make sense. Don't forget, you can usually get a line of credit against any equity in your property. If your loan is coming due and you want to hold your property then it is a no-brainer to either refinance or pay off the loan. It is important to know that when you sell you will most likely pay a taxes on the the original cost, not the refinanced amount and if a new buyer needs to assume your new debt in a low leverage situation with possibly higher interst rates in a future date, it could eliminate a lot of quality buyers in your property as most real estate investors want as much leverage as they can get in order to create a favorable cash-on-cash return on their investment. The assumption process can take several months which a lot of 1031 exchange buyers may feel is a risk not worth taking if a deal may not be able to close in time to comply with their 1031 exchange.
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| 3. Sell the Property and Pay the Gains Tax |
While this method is often used by real estate investors, it is not necessarily the best option; and often is done without a full understanding of other available options. See: The Tax Problem Â
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| 4. Shelter the Tax Gain with Deductions |
Another option you have is to shelter your capital gains, the same as sheltering your ordinary income with either tax deductions or tax credits. There are many fine investment professionals who can advise you on tax deductions or tax credits. It is up to you to judge the risk of those investments your advisor recommends.Â
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| 5. Installment Sale |
Another option is to sell your real estate and receive an installment note; but this could be the worst tax choice of all. The result can be paying, perhaps, triple taxes.
First of all if you have a mortgage over basis situation, that will be taxed as ordinary income in the year of the sale - whether you take any sales proceeds or not. This often come as a complete surprise and the federal tax rate on ordinary income may be 34%.
Also in the year of the sale, you will have to pay the 25% tax due on the recapture of the depreciation, which may be more than the note and entire down payment. The only tax that is deferred with an installment note is the 15% tax on your appreciated gain.
Next, while you and your spouse are alive, you will pay your capital gains and state income taxes each year in which you receive a note payment; and then, when the surviving spouse dies, your estate may owe estate taxes on the notes remaining unpaid balance. Your heirs will inherit the remaining notes but they will continue to pay the capital gain taxes as they receive each note payment.
An installment note does not get a stepped-up basis at death. The combined, potential, triple taxation on an installment note could exceed 70%.
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| 6. Put the Properties into a Trust |
The fifth tax option is to defer capital gains using an irrevocable trust.
One trust that was popular and effective for sheltering real estate gains was the Private Annuity Trust. However, recently the IRS directly addressed these trusts and determined that going forward they were no longer a viable method for sheltering capital gains.
The most popular trust remaining for real estate investors is the Charitable Remainder Trust. These can be set up with an attorney. We recommend you consult with a trusted professional who is experienced in Charitable Remainder Trusts to determine the options for your specific situation.
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| 7. Tax-free 1031 Like-Kind Exchange |
With investment real estate there are two ways to employ a 1031 Exchange.
The first is to find, finance and manage all of the replacement properties yourself.
Or secondly, if you want to make your life less complicated you could purchase part of a bigger, better property that would not normally be affordable on your own. A property that should have better economies of scale - enough to afford professional management. This can be done by co-participating with a professional real estate company as a Tenant-In-Common (TIC) investor. The real estate company (sponsor), as perhaps the largest investor, manages the property with an owner’s motivation - like your own.
The 1031 Exchange rules are similar whether you purchase all of something or part of something. |
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