Reduce the stress of selling with a real estate exit strategy

You can reduce the stress of selling your real estate, avoid up-front realtor fees, reduce the applicable capital gain taxes, and receive an increased tax deduction...while providing an income stream that will never fluctuate. Whether you own single family, multifamily, commercial, or income producing property, it is possible to take advantage of Internal Revenue Code provisions which can save you both time and money. Property ownership requires the normal responsibilities: maintenance, collecting rents, seeking tenants, legal matters - just to name a few. Over time, this can become a burden and expensive, particularly when property managers are involved. A §1031 exchange permits the deferral of taxes when selling one property and replacing it with another. Even though this can be repeated, the ownership and capital gain problems remain. It is usually the intent to own income-producing property into and through retirement, but sometimes that is not possible. Personal or health issues, family matters and location are some challenges that might make it more desirable to liquidate. Many retirees leave their home area because of the desire for a warmer climate or a need to move closer to children and grandchildren. It is often difficult to manage real estate from a distance. Beware of the Unexpected The typical mindset is that when a real estate investment is sold, long term capital gain rates apply to the entire transaction - this is not correct. The fact is that multiple tax rates apply and it often requires the assistance of a tax professional to calculate the correct amount of tax. The total tax might be as high as 25% to 30%. The time to sell is when the price is right and a willing buyer is ready to write a check. With the activity of the sale, the tax aspect is often not a consideration until tax filing time. In the instances when tax issues are considered before the sale, some sellers increase the sale price to compensate for the higher tax. This tactic is more likely to hinder the sale rather than offset the tax bite. In other cases, owners simply refuse to sell, even if the circumstances are right, to avoid the tax. Another option is to leave the property to heirs at death to avoid the tax. Under the current law, a new owner by inheritance is not subjected to the previous owner's capital gain exposure. The fair market value becomes the seller's basis and no taxable gain or recapture exists. Astute buyers look for distressed situations and will attempt to purchase at a price lower than the market value. Furthermore, the property may have passed its prime and creates maintenance and repair issues for the heirs. A Real Estate Exit Solution Owners interested in selling investment real estate can now enjoy tax benefits from two little known sections of the Internal Revenue Code. The combined use of IRC §453 which deals with the tax treatment of an "installment sale" and IRC §1.1011.2 which deals with what is known as a "bargain sale." When used in combination with a §501(c)(3) charitable organization, it serves to significantly reduce the capital gain tax liability while creating a current income tax deduction and an income stream for a specified number of years. The process is commonly known as a charitable bargain sale with installment option. National Community Foundation, a 501(c)(3) nonprofit organization established in 1979, specializes in charitable planned giving, including charitable installment purchase agreements, which they refer to as ChIPs. Comparison An elderly couple has owned a piece of commercial property for many years. It has been rented to good tenants, has been well maintained and upgraded as needed. The couple has enjoyed the supplementary income, the tax savings from the depreciation and the satisfaction of seeing the property appreciate in value. When a realtor brings a qualified buyer with a good offer, it's time to decide. Assumptions: Current selling price: $500,000 Purchase price: $250,000 Property fully depreciated except for land: $ 25,000 Capital gain on $250,000 @15%: $37,500 State tax @5%: $12,500 Depreciation recapture at ordinary tax rate* 25%: $56,250 State tax @ 5%: $11,250 The total tax: $117,500 Net proceeds: $382,500 *Tax rate is based on individual's tax bracket. The ChIP Method Using the same criteria the process is as follows: Complete an option agreement with the charity to locate a qualified buyer for the $500,000 property and receive an income tax deduction of $294,612, which may be used to reduce adjusted gross income.** This creates the following benefits: Possible tax savings: $73,653 (25% bracket) Partial elimination of capital gain: $265,525 Annual fixed income for 25 years: $23,016 Included is the non-deductible portion of the capital gain of $209,475 allocated over the 25-year payout period. It is possible to defer the pay-out for up to 10 years and still receive the current tax benefits. **Non-cash deductions are limited to 30% of Adjusted Gross Income with a carry forward of 5 additional years; if needed. Summary of Benefits Monthly income for a fixed period. Partial capital gains tax elimination. Remaining capital gains is reallocated over the payout period. Current income tax deduction (may be used to offset other ordinary income). Flexible income starting point. Certain 501(c)(3) organizations absorb the real estate fees and closing costs by adjusting the payout rate. No start up fees or ongoing expenses. Some types of properties where this unique strategy has been used include: commercial/industrial, apartment buildings, rental property, lots/raw land, and farms Scenario Many business owners own the buildings and land in which the business operates and receive rental income. For example, an owner sells his business but retains ownership of the property as a retirement income source. After a few years they decide to spend the major part of the year at their second home, making it difficult to deal with the tenants as well as the maintenance and repair issues that arise. Being a remote landlord can become stressful, but there is a better solution. You can contact an organization like National Community Foundation which can tailor a Charitable Installment Purchase Plan for each particular situation. This allows individuals to utilize the resources of an established nonprofit to seamlessly market the property at a specific sales price while also reducing the tax liability. "The only place you can win a football game is on the field. The only place you can lose it, is in your head." (Darrell Royal) I have been associated with National Community Foundation for more than 6 years. They continue to provide professional assistance to clients enabling them to fulfill both their philanthropic needs and desires. This information is not intended as tax or legal advice. Please consult with your accounting or legal professional. John Cuomo is affiliated with the National Community Foundation and his office is located at The Partners, Vestal, N.Y.