Marc Schwartz teaches us 3 particular ways to lower or defer your taxes when selling real estate.
Learn more about Capital Gains Bypass Trusts, 1031 Exchange, and Installment Sales. Marc Schwartz explains the pros and cons of each.
Mike: Welcome back to the FlipNerd.com REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Mark: Hi, my name is Mark Schwartz and I’m from the Law Offices of Mark Schwartz. And I am going to be your teacher today for REI Classroom.
Now, the topic that we’re going to discuss today is How to Cash In On Your Real Estate Investment.
Mike: This REI Classroom real estate lesson is sponsored by VirtualStaffNow.com.
Mark: Now a lot of people are referring to cash out when they sell their property, but we’re going to talk about cashing in.
Now, there are a few ways we can do this. The simplest way and the way that most people understand selling real estate is you hire a broker, you sign a contract and you sell the property. The problem with that, even though it’s quite simple, is that there are going to be taxes due. And there’s something called capital gains, which is slightly lower than income tax, but at the end of the day, not much. So, if you just sell your property and you want to pay your tax, you’re looking at about 34% of the difference between what you bought the property for and what you sold it for. It’s actually a little bit more complicated than that, but more or less, that’s what’s going to happen.
So a lot of people don’t like paying taxes. If you’re anything like me, you definitely don’t like paying taxes. So, let’s explore some different ways of not doing that.
One way to do it is we can do what’s called an installment sale. Now under an installment sale, the seller takes back a portion of the purchase price. Basically the seller is almost like a lender to the buyer. And that’s great because you only have to pay taxes on the money you receive. Sounds good. But of course there’s always a negative.
In installment sales, people may stop paying and then you got to foreclose, which is a really big pain in the ass. Sorry, I don’t mean to swear. But sometimes in real estate, things get a little bit messy.
Also with installment sales, you’re still involved in the transaction. I had a client recently who did this and the buyer ended up suing him. And it was quite a mess because the seller really had a conflict right there between being the former seller and being the lender. So not always the best thing, installment sale, but as I said, there are advantages.
Another way and probably one of the more common ways that I see in people getting out of their real estate project, especially when they’re tired of property management, is they do what’s called the 1031 Exchange.
Now the government loves real estate. It’s probably the favorite child of investments. Because the government will allow you to sell your property, take all of that gain and put that into a new property and not have to pay any taxes right away. In fact, you can actually defer those taxes forever if you die with the property. But even if you don’t, you’ve at least deferred or delayed the taxes for quite some time.
A lot of clients that I have will do that and they’ll go from let’s say a house or an apartment building into a triple net deal. A triple net deal with maybe like a Walgreens. And the advantage there is you don’t have to worry about maintaining the property. Usually those triple net deals, the tenant will take care of all the maintenance and basically you just collect the check every month.
Disadvantage there is you still have the property, and if that tenant ever goes out, you’re going to have a big box that you’re going to have to fill, and there maybe some income that you may lose while you’re trying to put a new tenant in there. Plus on top of that, you may have to get some lower rent. If you ever have any questions on that, I’m more than happy to explain it to people, but it’s a fantastic deal for some, not so fantastic for others.
Now the final thing that we can do when we’re trying to cash in on our real estate, is we do something called a “capital gains bypass trust”. It’s a mouthful, isn’t it? In the legal industry it’s often referred to as a charitable remainder trust. A lot of people do not like the word charity, scares them for whatever reason. But if I tell them they’re going to avoid capital gains, that gets their interest.
So the way the capital gains bypass trust works is you sell your property and you don’t pay any taxes. Zero. None. In fact, you actually get an income tax deduction. Because you’re going to be donating that property or a portion of that property to charity.
Now, there are some formulas that we need to figure out. But just for discussion purposes, let’s just say that we’re donating the whole thing to charity. Now the way this was going to work or is going to work is you are going to put your gain into a trust. A charitable remainder trust or as we’re calling it, a capital gains bypass trust. And the charity, which by the way could be something that you set up for your family to direct, is going to receive that property when you die. In the meantime however, and this is the beautiful part about the charitable remainder trust or the capital gains bypass trust, is you get to keep the income for life. I’m going to repeat that. You are going to keep the income for life.
Now it’s not too hard to think about. If you have all of the gain from the property that you just sold, you’re going to get a lot more income than if you sell the property, pay the tax and then invest it.
So if lifetime income is important to you, the charitable remainder trust or this capital gains bypass trust is a really, really good alternative. It does require an attorney and it does require an accountant, but it’s something that you should definitely look into.
I hope I’ve given you a good brief overview of ways that you can cash in on that real estate investment that you made. I hope to have another opportunity to talk to you. I happen to love real estate, I happen to love real estate law, and I happen to love teaching it.
So really appreciate you all taking the time and good luck with your real estate investment.
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