Legal/Tax Suggestions for Seller wanting to preserve step-up tax shield benefit

[Dan Becker]

Hi All,

I am looking for deal structure suggestions on a unique situation that involves a home held in trust.

I have a seller who owns and rents out an SFR that has an FMV of $~2M. He and his wife hold it in a revocable trust with plans for the asset to be distributed to his adult children. The property is in California, so the children will get the benefits of a locked-in property tax assessment value that is at least half of similar properties ($27k), and when the children do sell, they will get a step-up in cost basis for ~$1.6M on the eventual sale. Assuming a 30% tax on the gain, I am ballparking that benefit to be a $480k tax shield for the children.

However, the owners would prefer to sell now.  Primarily because home prices in the area are expected to flatline / deflate/ correct,  but also because the property was built in the 50s and more serious deferred repairs and maintenance are starting to compound.  It is becoming a lot for the 80-year-old owners who are expecting greater costs in time and dollar (self managed).

Is there any creative deal structure that can be used so that I can buy and occupy the home including the assumed improvements, repairs and maintenance, while allowing the seller to preserve the step-up tax shield for their descendants?  The other constraint, the seller is not interested in a 1031 exchange if it means owning/managing another property.

So far, the only concept I can think of is something like a contingent title transfer upon closing.   I'm not sure if there is such a deal structure or even the risks involved if engineered,  but the idea would be that the title doesn't really transfer / and a final balloon payment isn't made until after the property actually transfers to the children.   

Is this a feasible concept, are there other concepts to consider?

All thoughts welcome, and thank you!

--DB

[Benjamin Weinhart]

Hi Dan,

Great question! Since the trust is revocable in this case, I feel that it's more or less irrelevant for the situation as all items would get treated similarly. I have seen it before with a few of my clients that they were able to utilize a Sec. 721/1031 transfer to move the assets into a REIT or other similar activity depending on the type of business. This would be a conversation to have with a qualified intermediary. Since the trust is revocable, the basis would still be stepped up on the date of death of the last grantor of the trust. This is just one of the items available to them, there's a few other avenues to take but thought I'd mention the most common I've seen.

[Katie Balatbat]

@Dan Becker

It sounds as though you are not the child of the seller?  If so, I'm not sure how you're envisioning qualifying for the parent-child exclusion for property taxes?  Note that under the newest Prop 19 laws, the parent-child exclusion is generally only available for a property that was the parent's primary residence that becomes a child's primary residence within 1 year of the transfer.

*this post does not create an attorney-client or CPA-client relationship.  The information contained in this post is not to be relied upon.  Readers are advised to seek professional advice.

[Joe Vesey]

Quote from @Dan Becker:

Hi All,

I am looking for deal structure suggestions on a unique situation that involves a home held in trust.

I have a seller who owns and rents out an SFR that has an FMV of $~2M. He and his wife hold it in a revocable trust with plans for the asset to be distributed to his adult children. The property is in California, so the children will get the benefits of a locked-in property tax assessment value that is at least half of similar properties ($27k), and when the children do sell, they will get a step-up in cost basis for ~$1.6M on the eventual sale. Assuming a 30% tax on the gain, I am ballparking that benefit to be a $480k tax shield for the children.

However, the owners would prefer to sell now.  Primarily because home prices in the area are expected to flatline / deflate/ correct,  but also because the property was built in the 50s and more serious deferred repairs and maintenance are starting to compound.  It is becoming a lot for the 80-year-old owners who are expecting greater costs in time and dollar (self managed).

Is there any creative deal structure that can be used so that I can buy and occupy the home including the assumed improvements, repairs and maintenance, while allowing the seller to preserve the step-up tax shield for their descendants?  The other constraint, the seller is not interested in a 1031 exchange if it means owning/managing another property.

So far, the only concept I can think of is something like a contingent title transfer upon closing.   I'm not sure if there is such a deal structure or even the risks involved if engineered,  but the idea would be that the title doesn't really transfer / and a final balloon payment isn't made until after the property actually transfers to the children.   

Is this a feasible concept, are there other concepts to consider?

All thoughts welcome, and thank you!

--DB

A DST or DST to 721 UPREIT is a potential option. Please shoot me a note if you'd like to discuss.

[Dan Becker]

@Benjamin Weinhart

Hi Dan,

Great question! Since the trust is revocable in this case, I feel that it's more or less irrelevant for the situation as all items would get treated similarly. I have seen it before with a few of my clients that they were able to utilize a Sec. 721/1031 transfer to move the assets into a REIT or other similar activity depending on the type of business. This would be a conversation to have with a qualified intermediary. Since the trust is revocable, the basis would still be stepped up on the date of death of the last grantor of the trust. This is just one of the items available to them, there's a few other avenues to take but thought I'd mention the most common I've seen.

Thank you for the reply. I just skimmed a short summary on 721 + 1031 deals. To confirm, the idea is that the owner would exchange proceeds from the home sale, for fractional ownership in an REIT institutional grade property with an intermediary (1031 portion). Then after 2 years that fractional ownership is exchanged for shares/member units in the REIT (721 UPREIT portion)?

Assuming that is close to correct, I think the owner will likely find this complicated and make it a hard sell.  How often / mainstream does this type of transaction occur?

I am hoping to find a more simple / crude (maybe) way to engineer a deal that simply holds the final sale until after the owner's title converts to the irrevocable trust, but based on the terms agreed to today.

[Dan Becker]

Quote from @Katie Balatbat:

@Dan Becker

It sounds as though you are not the child of the seller?  If so, I'm not sure how you're envisioning qualifying for the parent-child exclusion for property taxes?  Note that under the newest Prop 19 laws, the parent-child exclusion is generally only available for a property that was the parent's primary residence that becomes a child's primary residence within 1 year of the transfer.

*this post does not create an attorney-client or CPA-client relationship.  The information contained in this post is not to be relied upon.  Readers are advised to seek professional advice.

 Hi Katie,  thank you for the reply.  Correct I am not the child of the owner.  I am not planning to qualify for the parent-child exclusion.  I mentioned it only as one of the interests of the owner / children that I would have to address for a proposed sale.

I could benefit from it (I believe) if I offered some type of lease option. Where we agree to a future sale, with seller financed payment terms today that are paying the T&I.

[Dan Becker]

Quote from @Joe Vesey:

Quote from @Dan Becker:

Hi All,

I am looking for deal structure suggestions on a unique situation that involves a home held in trust.

I have a seller who owns and rents out an SFR that has an FMV of $~2M. He and his wife hold it in a revocable trust with plans for the asset to be distributed to his adult children. The property is in California, so the children will get the benefits of a locked-in property tax assessment value that is at least half of similar properties ($27k), and when the children do sell, they will get a step-up in cost basis for ~$1.6M on the eventual sale. Assuming a 30% tax on the gain, I am ballparking that benefit to be a $480k tax shield for the children.

However, the owners would prefer to sell now.  Primarily because home prices in the area are expected to flatline / deflate/ correct,  but also because the property was built in the 50s and more serious deferred repairs and maintenance are starting to compound.  It is becoming a lot for the 80-year-old owners who are expecting greater costs in time and dollar (self managed).

Is there any creative deal structure that can be used so that I can buy and occupy the home including the assumed improvements, repairs and maintenance, while allowing the seller to preserve the step-up tax shield for their descendants?  The other constraint, the seller is not interested in a 1031 exchange if it means owning/managing another property.

So far, the only concept I can think of is something like a contingent title transfer upon closing.   I'm not sure if there is such a deal structure or even the risks involved if engineered,  but the idea would be that the title doesn't really transfer / and a final balloon payment isn't made until after the property actually transfers to the children.   

Is this a feasible concept, are there other concepts to consider?

All thoughts welcome, and thank you!

--DB

A DST or DST to 721 UPREIT is a potential option. Please shoot me a note if you'd like to discuss.

 Thanks, Joey.  

[Benjamin Weinhart]

Quote from @Dan Becker:

@Benjamin Weinhart

Hi Dan,

Great question! Since the trust is revocable in this case, I feel that it's more or less irrelevant for the situation as all items would get treated similarly. I have seen it before with a few of my clients that they were able to utilize a Sec. 721/1031 transfer to move the assets into a REIT or other similar activity depending on the type of business. This would be a conversation to have with a qualified intermediary. Since the trust is revocable, the basis would still be stepped up on the date of death of the last grantor of the trust. This is just one of the items available to them, there's a few other avenues to take but thought I'd mention the most common I've seen.

Thank you for the reply. I just skimmed a short summary on 721 + 1031 deals. To confirm, the idea is that the owner would exchange proceeds from the home sale, for fractional ownership in an REIT institutional grade property with an intermediary (1031 portion). Then after 2 years that fractional ownership is exchanged for shares/member units in the REIT (721 UPREIT portion)?

Assuming that is close to correct, I think the owner will likely find this complicated and make it a hard sell.  How often / mainstream does this type of transaction occur?

I am hoping to find a more simple / crude (maybe) way to engineer a deal that simply holds the final sale until after the owner's title converts to the irrevocable trust, but based on the terms agreed to today.

 You may want to talk to an intermediary as they'd have a lot more knowledge on how the whole process works than I would, it's fairly rare that I see something like this happen, but I usually get it once every year or two. You cannot do what you described in your last paragraph unless they also wouldn't be getting paid/other consideration until the year of the title transfer as well. I suppose they could do a long-term lease with a purchase clause in the lease itself independent of their deaths, but again, they wouldn't get the funds until the property actually changes hands.

[Sean Ross]

Quote from @Dan Becker:

@Benjamin Weinhart

Hi Dan,

Great question! Since the trust is revocable in this case, I feel that it's more or less irrelevant for the situation as all items would get treated similarly. I have seen it before with a few of my clients that they were able to utilize a Sec. 721/1031 transfer to move the assets into a REIT or other similar activity depending on the type of business. This would be a conversation to have with a qualified intermediary. Since the trust is revocable, the basis would still be stepped up on the date of death of the last grantor of the trust. This is just one of the items available to them, there's a few other avenues to take but thought I'd mention the most common I've seen.

Thank you for the reply. I just skimmed a short summary on 721 + 1031 deals. To confirm, the idea is that the owner would exchange proceeds from the home sale, for fractional ownership in an REIT institutional grade property with an intermediary (1031 portion). Then after 2 years that fractional ownership is exchanged for shares/member units in the REIT (721 UPREIT portion)?

Assuming that is close to correct, I think the owner will likely find this complicated and make it a hard sell.  How often / mainstream does this type of transaction occur?

I am hoping to find a more simple / crude (maybe) way to engineer a deal that simply holds the final sale until after the owner's title converts to the irrevocable trust, but based on the terms agreed to today.

 @Dan Becker,

There are lots of potential passively managed target replacement assets that could qualify for a 1031 exchange besides just a DST or 721-UPREIT.

For example, we commonly see commercial NNN TIC properties that investors trade into without any management responsibility. Or, your sellers could consider syndicated deals put together by reputable real estate investment firms that would allow the sellers access to income-producing assets that are professionally managed.

It seems that the #1 issue for the sellers is not recognizing taxable income and the #2 issue is that they don't want to actively manage their next investment, yes?  If that's true, there are still many potential landing spots for them that preserve the ability to 1031.  

As @Benjamin Weinhart mentioned, there are some potential stumbling blocks with trying to drag out the sale until parents pass away.  I think you'd need to work with a local attorney and CPA to make sure you're not tripping over any wires accidentally (to mix a metaphor). 

[David M.]

@Dan Becker

Many times in high value areas, the tax liability isn't nearly as high as some would lead you to believe...

Anyway, to you question:  no, there really isnt a great way for you to get the property and get the step up in basis.

Honestly, your question doesn't make sense:  "Is there any creative deal structure that can be used so that I can buy and occupy the home including the assumed improvements, repairs and maintenance, while allowing the seller to preserve the step-up tax shield for their descendants?"

Are you doing the first half where you buy and occupy?  Or the second half, where the heirs take Title?

Similar type deals have been asked before recently on bp.  We never came up with a good answer. the step-up in basis requires the owner's death.  If the current owners didn't need the cash, a master lease type structure could be a way to go to get you control of the property, but somehow a Will, or Trust in this case, would have to name you as the heir.  That's a pretty big risk on your part since both docs can be modified at anytime.

Again, what is your goal?  just to save them the tax?  For you to buy it at today's market price, or future price?

[Natalie Bender]

As mentioned prior, a DST may be a good fit for your seller and may help close your deal if they have an exit strategy they are excited about. Take a look at this blog post, you may be able to better understand your seller, anticipate their pain point and provide a solution they haven't considered. Shoot me an email if you would like to talk more.

https://www.biggerpockets.com/member-blogs/7993/48729-are-your-rental-properties-weighing-you-down