In 1775, some guy named John Adams said the following, “One useless man is a disgrace, two become a law firm, three or more become a Congress.” That Adams guy was pretty smart. The American people should pass a law to duplicate what we do here in Texas. Our state legislature meets every two years for about four-five months then they go home; the damage they can do is limited to that period of time.
Imagine a Congress that meets every two years. I know, wishful thinking. Unfortunately, when Congress is in session, things are going to happen, and all too often it’s not going to have a happy ending for the American people.
Congress has promised tax reform, but not spending reform, and therefore they have to find ways- below the radar ways- to generate more taxes to make up for the fact that everyone will be receiving some type of tax break. Enter Section 1031 of the tax code.
1031 exchanges have played an integral role in buying and selling real estate for decades, but now Congress has its sights set firmly on exchanges and when Congress focuses on a specific situation, it’s probably not going to end well. I suspect this is going to be the case.
I have seen where Congress might place a $1 million cap on exchanges or revoke 1031 exchanges outright. Assuming this happens, let’s be proactive and discuss a potential option for deferring taxes when selling a great property. Those taxes include the capital gains tax, state tax, depreciation recapture and the Obamacare tax, as long as it still exists.
Fortunately there is a great, but little known proprietary program that will continue to be available based on Section 453 of the tax code that will help the land for sale owner to still defer taxes. In some ways, this program may have more flexibility than a 1031 because there is no 45 or 180 day periods, no loan to value ratios, and the seller can buy any type of property at any time in the future.
Consider these opportunities:
- A property owner would like to sell and transact a tax deferred sale. Section 453 might be a great option because there are no time constraints that could cause the transaction to fail.
- A property owner would like to sell and retire and move closer to the grandkids. Using Section 453, he can sell his property and still defer taxes, which will create a larger retirement income. The property owner can go spoil his grandkids to get even with his kids for being so rotten when they were growing up!
- The sale of a high-end residential property creates a large capital gains liability. Section 453 can defer the capital gains tax, state tax, and the Obamacare tax, and the property owner can buy any property at any time in the future.
- There is more than one property owner on a property that is being sold. One or more owners want to sell and defer taxes and one or more wants to take the money and run. Not a problem. The owner/owners that want to defer taxes can do so.
- A property owner is going to use the stepped-up basis to avoid capital gains tax. Section 453 under certain circumstances may provide a better option for the land owner.
- A property owner would like to sell and retire but would like to invest in assets other than real estate. Section 453 allows the property owner to sell and diversify away from real estate if he/she so desires.
There are also advantages to the real estate broker. As mentioned above, Section 453 can be utilized in situations that a 1031 cannot. Imagine the farmer that owns land that has been in his family for decades. Now, because the kids aren’t coming back to continue the family’s farming tradition, the farmer decides that its time to put the farm for sale and retire. Imagine the “value added” that the broker can bring to the table by being able to defer the farmer’s capital gains tax, state tax, depreciation recapture and the Obamacare tax on his hard earned sales proceeds. All of that occurs after you receive your commission check. Best of all, you help increase that hard working farmer’s retirement income by roughly 30% for the rest of his life.
Say a seller wants to find a replacement property before accepting an offer on his property. As his broker, you bring several great offers to the table but the seller turns them all down. That has to get really old. So, what about this option: Section 453 will allow the seller to sell his property now, defer his taxes now, the broker gets paid now and the seller has an unlimited amount of time to find whatever property that he would like to buy at any time in the future. Everyone wins but Uncle Sam.
One final comment. Over the past 20 years, the Section 453 tax deferral strategies have been utilized successfully over 2000 times with the largest transaction being $130 million with a tax deferral of $50 million. These strategies have been reviewed extensively by the Internal Revenue Service (IRS) and have passed every IRS audit that has been conducted. Again, because this is a proprietary program, it isn’t well known but can be a powerful tool in a brokers’ briefcase when competing with other brokers for a great listing.
I hope that Congress makes no changes to 1031 exchanges, but I have also been hoping to see my Oilers/Texans in the Super Bowl just once, so my track record for hoping isn’t very strong. The bottom line is that if Congress does make changes, you have options that your competition probably doesn’t.
I feel like John Wayne riding to the rescue to chase away the bad guys. Actually, maybe I am except my bad guys don’t have guns and haven’t shaved in a few weeks. So don’t let any of this create an obstacle to your real estate practice and or in helping your clients. Keep buying and selling great properties and if you need help deferring taxes, I am a phone call or email away.
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This is a very good article although the largest 453 transactions is several billion dollars.
Summaries of several public companies that have executed this transaction for as much as four and a half billion dollars are summarized on our website http://www.liquidcappartners.com/blog
We implement this strategy internally at our firm and happily cooperate with other professionals.
As an individual who has established his net worth from income earned through labor, investments in stocks, and investments in real estate, I have always been troubled by the way each is taxed. Why should a dollar I earn through my labor be taxed at potentially well over 50% when I include federal, state, FICA, and Obamacare taxes? Why should a short term capital gain on a stock investment be taxed at the same rate, while a stock I hold for 12 months or more be taxed at substantially less? Why should the profit I make in a real estate transaction be Zero if I use to loophole of a 1031 exchange to purchase a new property? Why should my children, who had nothing to do with this property investment, or any of my other investments, eventually be able to inherit this property with a stepped up cost basis and be able to sell it paying no taxes? Yes, the farmer has worked hard, but so has the laborer, or the person who grew his investments owning and funding the stocks of companies. I believe all categories, wages, real estate investment profits and non- real estate investment profits should be taxed equally. I also believe that my children should not benefit from being members of the “Lucky Sperm Club” and should pay an equivalent tax rate when they inherit my assets as it is now a form of “income” or “profit” to them. With all this being said, I believe that the producers of society are generally over-taxed. Especially those who try to grow their wealth through earned income. I also wish our government would work a hell of a lot harder on “Spending Reform”. In short however, our tax code should be much flatter and simpler. Taxes on Labor and Capital should be the same to put no one at a disadvantage, and the goal should be to constantly drive these equal tax rates lower. As someone who started with nothing, I believe we should have a tax system that makes it easier to start with nothing and amass wealth, but not allow inherited wealth to compound into a dynasty to heirs that had nothing to do with creating that wealth.