Exit Strategy for rental properties

[Patrick Murphy]

During the crash I was fortunate to be able to purchase 9 rental properties between 2008 and 2012 at incredible low prices. I am now 60+ years old and replacing toilets, climbing on ladders is getting old. I am trying to figure out how to exit this investment with limited tax liabilities, each property has increased in value by 500% since I purchased them. I have steady and fantastic renters and they have paid my initial investment 2 times over. All homes are owned free and clear. My question is this: Should I bundle them all together to get my best price for income property? or should I sell them one at a time as SFH's and spread the tax liability out over several years? or should I work with the tenants and do land contracts to sell them the properties at a higher interest rate and higher asking price because I am sure none of them have enough for a decent down payment and also I am concerned that interest rates will increase and I will be stuck holding a low interest loan and my money could go somewhere else, also I do not want them back. I am a licensed real estate agent here in AZ but this is just a question to this community. Any experience with this would be greatly appreciated.

[Clayton Mobley]

@Patrick Murphy Firstly, congrats on your awesome foresight! As usual, I agree with @Dave Foster - I'd look into the 1031 exchange option if you want to stay invested in RE but think your money could be deployed into bigger and better elsewhere. You could, technically, just keep leapfrogging properties through 1031s until you die and leave your final props to your heirs, who would receive a stepped up basis (not owe taxes on the sale unless they held it long enough for it to appreciate further). If you want to stay in REI, I would recommend biting the bullet and getting a PM - its going to make your life so much easier.

Now, a more complicated option (but one with some great long-term benefits) would be to consider a Charitable Remainder Trust. You'd deposit the properties into the trust - it's irrevocable so you can't get them back BUT they don't count as part of your estate anymore (especially useful if your estate will be over the $5.5 million threshold - for now anyway). The long and short of it is that the trust would sell the props and reinvest into other income producing assets, and you could draw income from the trust during your life, and then whatever remains when you pass would go to your chosen charity (or educational institution, they reeeeealllly push this on their wealthy alums, but I like the idea of funding a worthy charity, personally). But of course it's a little more complicated than that.

Since your current REI is still cash flowing nicely, you'd likely opt for a FLIP-CRUT trust, which starts out as Net Income Charitable Remainder Unitrust (NICRUT) and then turns into a standard Charitable Remainder Unitrust (CRUT). Basically, a FLIP funded with income-producing RE passes on net income (rents) initially and then, at a point that you specify when you create the trust, the trust will 'flip' to paying you a flat rate of income based on the trust's total value. Usually this trigger is the sale of the properties. The trust sells the properties, you pay no taxes because the properties don't 'belong' to you anymore, the trust pays no taxes because it's a charitable entity (this solves your current problem). The trust then reinvests the proceeds into other income-producing assets (bonds, funds etc). The value of the trust grows due to these earnings (subject to market risk, but not to real estate market risk anymore) and you draw a set amount each year (say 5-7% of the total value, you have to decide the amount when you create the trust). When you die, the remaining value of the trust passes to your charitable beneficiary.

Since the downside of this is that your heirs don't benefit from inheriting those properties, many people create a separate irrevocable life insurance trust (ILIT) to hold a life insurance policy purchased to benefit your heirs for the same value as the properties in the FLIP trust. You use the income from the FLIP to pay the premiums on the insurance policy, thereby taking the value from your properties and parlaying it into a tax-free benefit for your heirs (it's in a trust so it doesn't go through probate either). The remaining annual income is yours, and you don't have to pay the capital gains or depreciation recapture taxes on the sale of your real estate.

Obviously, this is not a DIY process. And you could build an even bigger legacy by using the 1031 exchange first (maybe multiple times) to leapfrog into even more lucrative properties. However, in terms of an retirement-till-end-of-life strategy that provides consistent income for you, a legacy for your heirs, and a nice little tax deduction for that charitable contribution (did I mention you get to take a that deduction in the year you create the trust and carry it forward up to five years, if necessary, though present-value math applies, of course ;) - the CRT can be a hugely powerful tool. 

If you go this route you'll need some pros on your team - a Qualified Intermediary for 1031s, a tax man, and fiduciary financial planner to help with the ins and outs of the trust. And, of course, it's not free - you have to pay administration fees, find an independent trustee, etc. 

Again, if you stay in REI, I'd say just get a PM, regardless of your next/final strategy. If you put your rentals in a CRT, you can't self-manage them anyway since they are no longer 'yours'. You've already got some amazing value producing income, sounds like it's time to just make this investment a little more passive.

Mandatory Disclaimer: While I am, obviously, a big fan of this financial tool, I am NOT a financial professional and you should absolutely do your own due diligence, talk to fiduciary (super important) financial pros and assess this option in terms of your own personal financial situation and goals. We have worked with plenty of clients that use the 1031, CRT or 1031/CRT combo, but that doesn't necessarily mean it's right for you. BP is a great place to hear ideas and learn from other's experiences, but you've got to vet vet vet every strategy on your own.

Sorry for the ramble (classic me), you are in a great position right now and you have multiple lucrative options available to you. Do your homework, ask some pros, and take your time - you're not losing money right now so there's no huge rush to pull the trigger, time is on your side. 

Best of luck!

Clayton