Tax Stategies for a 1M+ real estate sale

[Shadonna N.]

I know an owner (very old school) who is ready to retire and liquidate his portfolio.  He has a few buildings in DC valued at over $1M .  He has already started to sell off some of his properties.  He does not employ any tax strategies and pays the maximum tax when he sells.  Properties are paid in full.  Guy is very old school, no debt, straight deals.  We are trying to offer suggestions for him to minimize his tax obligation without making things too complicated.  Could a trust be used?  What about an exchange?  Is it always real estate for real estate?  Any ideas?

[Dave Foster]

@Bill F., @Don Konipol I love the dialogue.  I certainly respect your opinions and you're both absolutely right - the 1031 is not for every transaction.  I've been doing them on my own investments for over 20 years and have to say that yes there are times when the 1031 was not the right move.  But those times were the minority.  And given that there's been an average of around 400,000 1031 exchanges accomplished every year since 1997 I wouldn't think these are all being done by short sighted tail wagging the dog kind of people.  Can I offer a bit of a counter point?

1. The $83K tax bill that was mentioned by Don - is it small in relation to a$1 mil gain? Sure.  But it also represents about $6,000 of annual income if invested at 7%.  $6000 may not seem like much but it's real money.  And if you take that $6000 out 10 years in a compounding reinvestment model over 10 years then that little bit of savings becomes $100K.  And that's how wealth is built.  What you keep is every bit as important as what you make.  

2. Of course #1 would be moot if as Don said the costs of trying the 1031 are as much as the tax savings.   But they aren't - not even close.  A 1031 of that size would cost around $1000 - $2000.  Now certainly Don was also alluding to the outcome of a bad purchase to accommodate the 1031.  That's a valid concern.  But to follow the "stepping over dollars to pick up dimes analogy.  Why would any investor intent on purchasing more real estate not be willing to spend $1000 to purchase the opportunity to save $83,000.  If they cannot find suitable replacements then let the exchange die.  You just lost $1000 and your tax plus loss is is now $84,000.  Not much of a difference is it.  And yes, we do have a few clients who do just that.  But the vast vast vast majority of folks who start exchanges find replacements that meet their investing requirements.  

3. Bill I'd actually say that the smaller the gain and the investor the more important it is to shelter as much of the profit as possible. It's not the huge contributions at the end of a working career that make your IRA look good. It's the small drips and drops over the years. The 10,000 of tax saved by a young investor now will be far more impactive on their life than the $83,000 paid by the investor above at the end of their career. Another perspective on the power of compounding.

4. Besides the "people settle on sub par replacements" deal , the other phantom fear I hear all the time is "better to pay the taxes now than when they go up".   I spose that might be true.  But since we're in an 80 year cycle of decreasing or stagnant  taxes https://bradfordtaxinstitute.com/Free_Resources/Federal-Income-Tax-Rates.aspx . and https://www.fool.com/retirement/2017/02/11/a-95-year-history-of-maximum-capital-gains-tax-rat.aspx it's a little hard to take that fear too seriously.  And if that's really then case then why the heck is my accountant and every financial advisor under the sun yelling at me to maximize my 401K and IRAs???  Because tax deferral is an incredibly powerful force that will change your life if you exercise it with discipline and consistency - particularly when you're young.

I think the situation is really more like what @Jay Hinrichs said.  Folks don't understand it.  A tool is only as good as the wielder.  Where' people falter is in not understanding the options to use it in various sectors and stages of a market.  It's a long term benefit for sure just like any other tax advantaged vehicle - from bonds to 401Ks and IRAs.