All Forum Posts by: Sean Ross

Quote from @Bill B.:

1) with a CRT you are giving the money away. Irrevocably. So do you want to give that money away?

2) lets use your 1031 exchange example. You’re selling one property for $200k that you paid $50k for. You buy 1 x $100k property but not the other. So you give $100k away to a charity and you have a $50k cost basis on the remaining property. (Mostly what I’m doing here is confirming you know at you have to spend all the sales proceeds, not just the profits, since you stated such low numbers.) then you would owe no taxes, but you have given away half your money. 

3) the good news is you gave the charity $100k not $100k minus taxes. The bad news this might/probably had to be done at the time you sold the property? It’s certainly not going to make your 1031 valid.

You’re probably going to need a charity you want to give the $100k to, a good cpa and a great 1031 QI. @Dave Foster have you ever combined a 1031 with a CRT? Anyone else want to weigh in?

We see CRTs as an end game for some investors who have already competed one or several 1031s. 

Basically, the charitable remainder trust is, as Bill pointed out, irrevocable, and will pay you an income over your lifetime and distribute the remaining funds to whichever charity you like upon death. Using a 1031 exchange property to fund a charitable remainder trust will let you keep deferring capital gains (as no tax will be due on the sale of the property by the trust) since it's a charitable entity. Rather, you'll receive an income for life and then a charitable deduction in the amount of the expected remaining balance given to the trust. 

If you are OK not leaving the balance left over to your family, This is a very good tax efficient option that can aid a cause you care about. 

Quote from @Ed Ma:

Yes, loan balance is about 118k @3.5% and property taxes are low due to Prop13.  I'm just worried if I sell it will be a huge tax hit. The 1031 seems like an option.

I'd also have to find a property outside of CA too.

 Ed, your top priorities for a potential replacement property sound like

1. Cash flow
2. Less or no management

?

Are there areas that you're intuitively attracted to?  Or does geography not matter to you?

@Annette Homewood,

I sympathize completely with your predicament. It really sounds like you've got stressful assets and aren't clear about which step to take next without making a mistake. 

You've also clearly done some homework already on DSTs, which is more than a lot of investors do (unfortunately). 

Let me take a whack at some of your "don't know" issues:

Will there by surprise fees? Possibly. Not all DST sponsors or brokers are comfortable breaking down their fees in clear, simple, direct language. DST fees include (1) typical escrow/title/appraisal/legal fees (as with any real estate transaction), (2) capitalized reserve fees that are typically paid upfront since DSTs can't use capital calls or borrow new money, so there are fees that help pay for the DSTs to raise all of the money it needs at the beginning, (3) selling commissions especially if you're using a DST broker, and (4) offering expenses for purposes of running the DST marketing and legal costs. Ask any DST provider/broker to list out these fees and how they impact your return.

Extra fees to cut into your equity? Over the life of a DST, sponsors will take asset management fees and they'll also often take out disposition fees upon sale that might not be subordinate to your investment...which will have the practical impact of cutting into your return on equity.  However, unlike a normal property that you manage, all of the costs and fees are "baked in"...you'll never come out of pocket to pay anything with a DST after you've invested.  

What else you should look out for? Yes, but I think the most important is to broaden your potential search a little. DSTs are useful in some circumstances and are extremely well advertised, but they aren't the only passive investment game in town for you if you're looking to 1031 exchange out of your headache properties. There are other NNN options, although there aren't any options that are going to come with mutual fund-level low fees. This is real estate after all.

Some alternatives to DSTs:

- Any property you buy could hypothetically become a triple net lease property. 

- A NNN tenants-in-common (TIC) property, which is in many was the structural predecessor to DSTs. There are meaningful differences, but they're still passive and often a good route if you're boxed out of accredited investor-only assets.

 - Oil/gas or other mineral rights, which will provide a passive income stream and are 1031 eligible

- There are other syndications out there that aren't structured as a DST, but a lot of them are going to have accredited investor requirements.

Let me know if you have other questions here. I think right now you're on the right path in terms of trying to evaluate the landscape for potential exits.  Be alert -- and I'm sure you already are -- that everyone tied to a company (myself included) is going to be incentivized to give you advice that leads to their service or product.  Ask around. 

@Ed Ma, 

I want to second @Nathan Gesner's advice here -- perhaps only sell if you are relatively confident in your landing spot being an improvement for you. 

It's harder to finance good properties right now for obvious reasons, and if you go NNN or DST then you need to be very clear about the costs (upfront and ongoing) that might eat at your returns.

Since you mentioned NNN, I'm guessing that you aren't in love with actively managing property in perpetuity moving forward. There are lots of options for you there via 1031 exchange if you can be confident in what you're looking to replace your investment with and why.

If your rental is in CA, then you'll have the issue of giving up the low property tax base.  If you want to 1031 exchange to a property outside of CA, then you'll want to be careful about how the California Franchise Tax Board makes 1031s more difficult (no surprises there) when leaving their jurisdiction. 

As a 1031 QI, I'm obviously a fan of 1031 exchanges.  But only in the right circumstance.  Maybe selling into something with better numbers or lower headaches is the right decision for you, however I want to encourage you to speak with a few different experts along the way so that you can account for all of the important variables. 

Quote from @William Coet:

Trying to spell out the benefits of seller financing to a seller.  Any suggestions are welcome.

Info: Seller owns the multifamily house  outright and has owned it for 40 years.  They will be facing a capital gains payment of around $110,000 (Ouch!).

Questions:

1.  If i give them a down payment and they finance the sale over 20 years, are the capital gains deferred or is it taxed at the income tax rate?

2.  If capital gains are deferred does that mean they pay each year? 

3.  Do they pay on the interest and the principal, or only one of them?

Thank you for any info.

 @William Coet, there is a lot going on with this potential scenario and I want to second the other advice being given here -- tread very lightly with specific tax advice for specific transactions, especially with seller financing. 

At a general level, capital gains taxes are recognized when the income from sale is received -- so a seller pays a pro rata share of capital gains on the purchase price as payments on the note are made.  However, they are also likely recognizing interest income (ordinary income tax rate) with each payment received, and most importantly they will recognize 100% of their recaptured depreciation in the year of sale. Recapture depreciation does not prorate over time across an installment note. 

Your seller should work with a competent CPA to thoroughly think through any potential sale with a carryback note. 

Quote from @Melanie Wilmesher:

TLDR: I found a seller who is open to a financing an off-market 5 unit multi family home near a major hospital in Denver. I am seeking advice on making my offer compelling but also making sure I'm not missing anything/potential expenses. Open to critical feedback.  

Two years ago, I found a multi family home on the MLS that sat on the market until it was eventually taken down. It was listed as a commercial property; a quadplex that also had a single family home on the back of the property (so two structures on one lot, zoned mixed use). It's a 5 minutes walking to a major teaching hospital in Denver, absolutely perfect for mid term rentals and long term rentals.

At that time, it was listed for almost $800k, more expensive than other comps. I reached out then about the sellers willingness to finance the deal and he was open to it but wanted at least $200k down. He needed a large down payment because he was paying for a home to be built. Today, I know that project is complete and so a big down payment up front is likely not a priority. 

Skipping to numbers; the quadplex has 4 1bd/1bth units, all currently rented for $1,100/per month. The SFH is a 3bd/1bth currently rented under market for $1,000/month. In total, it's generating about $5,500/month. The owner owns it free and clear and it's managed by a local property manager. The best comp I found is listed today at $900k, been sitting a month and is only a quadplex. The second best comp closed end of 2022 for $830k, 3 months after being listed and a price reduction of 40k.

I believe there is huge potential for this property. The SFH today is dilapidated and undoubtedly needs a face lift but because of the cashflow, the owner's not motivated to make repairs. Comps on distressed properties within a half mile that have sold in the last 30 days are closing in the $330-350k range alone and renting for $2,500/m with basic updates (think original kitchens) or $3,000/m for completely updated 3bd/1bths. Beyond that, the mid-term rent potential on the quadplex units is at the very least $1,500/unit per month once the leases are up (Mid term rentals listed today have a higher potential but would require updates to the units). Furthermore, based on it's location alone, this property could be sold to a developer because of the unique zoning that has no limit to the building height built on the lot (!!!).

So, back to making an offer... I want to make a compelling offer but want to make sure I set myself up for success too. I'm thinking about starting at 870k with 10% down and an interest rate of 5% with a 20 year term. This way, the seller gets 87k in hand, won't pay nearly as much taxes up front on a huge cash sale, will still be generating about the same amount of income as he is today, consistently for 20 years without the headache of managing it or insuring it.  

I'm open to any and all feedback regarding how I'm thinking about this, what I might be missing or how to make it more compelling. 

Thanks in advance. 

@Melanie Wilmesher, if your seller is planning on doing a 1031 exchange coming out of any potential transaction, he is going to find problems with an offer that hinges on seller financing.  It's not impossible to do a 1031 exchange out of a property while carrying back a note, but it's complicated enough -- if you're going to make the deal attractive to him, find out if he plans on looking at a 1031 and come prepared with information to help him navigate the hurdles that come with the seller financing. 

@Robert L.,

This is a really important question.  QI failures can fall into several categories: scammers who steal money or information, ineffective operators who can blow your Exchange and get the IRS after you, weak QI infrastructures that don't have adequate insurance or safety protocols against outside fraudsters, etc. 

It's a lot to navigate. Not enough people ask the questions that you're asking.  

How to find a reputable QI:

- reviews and Google searches are a good starting point, but not the end of the road

- referrals from a source you trust

- call and speak to your prospective QI. Ask for proof of insurance.  Ask for details about security.  Ask for references. Find out where they are holding your funds. 

- There are a lot of good folks on BP who have been in the game a long time and can vouch for different QIs

As for your DIY model: you can't do 99% of exchanges on your own, the IRS won't let you.  It's why companies like ours exist - we are creatures of the tax code.  You need an independent third party to act as QI.  And, even if you could, you wouldn't want to.   1031 rules are opaque and deeply unintuitive when taken as a whole.  The room for error is very large.  Lots of trip wires.  

Do you know what your tax liability would be if you sold without a 1031?

There are

Quote from @Spencer Speckles:

Quote from @Scott Winter:

I'm not totally following your reasons not to, so sorry if I'm misunderstanding your question.  Here are a few reasons sellers might offer seller financing when selling their property. It's definitely not for everyone, so don't feel like you're missing out on something.  

LOI - I'll offer you whatever value we agree your home is worth, I'll give you a down payment if you want, and I'll pay you 8% interest on the balance of the loan until it is paid off or sold in 30 years.  If you don't want to wait 30 years, we could amortize it over 30 years and have a balloon payment due in 10 in which case I'll refinance you out or sell the property.

Why are you selling the property?  Many sellers are tired of being landlords but wouldn't mind collecting a check every month still.  As a lender, you don't have to deal with the tenants and maintenance, just collect the payment.

What are you going to do with the money?  Sure you could invest it in something else, but many real estate investors know real estate really well and are most comfortable in that space.

What is your tax situation? Many people are at different stages of life and income may be high so selling outright may lead Uncle Sam to take a much larger portion of their income.

 Thank you for breaking it down. It sounds like I am not in a situation where it would make sense. For me, the buyer’s interest payments wouldn’t be close to the current cash flow and I’d have to pay capital gains taxes, so I’d lose even more. My other properties are commercial, non-residential properties where I make more with a lot less headache. I’d use the sales proceeds to 1031 into a commercial building. 

Your comments suggest that it’d be better for me to sell it outright. Thanks for your help.

@Spencer Speckles,  there are additional complications if you try to carry back a note while performing a 1031 exchange.  Lots of tripwires from the IRS.   If you're looking to do a 1031, this adds one more reason to shy away from the seller financing. 

Quote from @Forrest Brown:

@Dan H. Those are great points to stay in the market. Thank you for the feedback!

@Sean Ross That's a gold mine of info. Thank you for this feedback. It sounds like it would be easier (time being the best asset) to just sell and pay taxes up front if my goal is to get a clean break from Cali?

@Zeke Liston @Bradley BuxtonbuWe are heavily considering Boise, ID or Chattanooga, TN and doing multi-family or buying a primary residence and house hacking/ adding an ADU. Thoughts?

@Steve Meyers I appreciate the link with your guy! I'd love to make contact with him and just got an understanding of the viability? 

 @Forrest Brown,  

I'm never a fan of telling anyone that writing a check for taxes is the best idea, but it does depend on your goals and your potential tax liability upon sale.  If you're total taxable gain is relatively small, then it is easier to justify paying the tax and avoiding the headache.  If your total taxable gain is not small, then obviously you're going to see more value from going through annoying compliance with California. 

Do you happen to know what your tax liability upon sale would be?  It's appreciated a little less than $200K with $115K worth of improvements, but how much depreciation have you taken?

When you look at your tax liability, consider that your depreciation will be recaptured at 25% federally.  The long-term capital gains will be at 15-20%.  You'll likely pay an extra 3.8% on some (or all) of the profit from the Net Investment Income Tax.  And all of those forms of income will face additional taxes from California, which I believe top out at 13.3%.   

Once you have the number of your potential tax hit (and, by extension, how much you can defer with a 1031 exchange), you can compare that to the effort you'd have to make to comply with California.

When it comes to making sure that your potential exchange is buttoned down, that is largely a matter of working with the right QI partner. 

@William Coet,

as @Chris Seveney and @Kevin Sobilo mentioned, they very likely are either (A) already diversified, or (B) committed to real estate philosophically, or most likely (C) the tax advantages that come with owning and depreciating property, had done prior 1031 exchanges, etc.