Our Section 453 Proprietary Trust is a Better Option
The Biden administration has made several proposed tax law changes that could have a major impact on rural markets. The proposed tax law changes are (1) the elimination of 1031 exchanges or a dramatic reduction in the benefits of a 1031 to $500k, (2) the elimination of the stepped-up basis, (3) the doubling of the capital gains tax to 39.6% AND Biden wants to make that retroactive to April 2021, and (4) the reduction of the federal estate tax exemption to $3.5 million and the tax rate on the taxable estate is increased to 45%. If I wanted to shut down real estate, this would be a great start. The good news is that there is a great option available today that is a better opportunity than a 1031 whether they are eliminated or not and that’s what we are going to discuss now and in upcoming blog articles.
Our Section 453 proprietary trust is a better option today than a 1031 for several reasons. First, we are not bound by Section 1031 guidelines. No 45-day or any other time constraints, like kind properties, loan to value ratios, holding periods or any other 1031 requirements. Imagine if you can sell today, defer taxes today and have an unlimited time to buy another property AND if you downsize, it does not create a taxable event. Working together, we can. Say you want to sell and retire and do not want more real estate. No problem. You can sell today, defer taxes today and retire today with a larger pretax lifetime retirement income than if you paid taxes first. All of this can be passed on to your heirs. A 1031 can not accomplish any of this.
In a 1031, you buy low and sell high but because of time constraints you may have to buy high. Working with us, you buy low, sell high and buy better. There are several additional advantages to our proprietary trust over a 1031. For example, you want to buy more real estate and depreciation plays an important role in the purchase of a new property. In a 1031, you do not get a new depreciation schedule on the replacement property but working with us, you do. So, you are able to receive the benefits of depreciation while you own a property and then you are able to fully depreciate the replacement property and increase your real estate wealth with the extra depreciation benefits that we can provide.
Maybe even better, let’s say that you have fully depreciated your property and now you want to sell and retire. When the property is sold, you must bring back depreciation recapture into the sale for tax purposes just like the capital gains tax, state tax and the Medicare tax. However, when selling your property using our Section 453 proprietary trust, you can defer all of the depreciation recapture in addition to the other taxes so not only can you reduce your taxes through depreciation when you own the property, you can also defer the depreciation when you sell which increases your real estate wealth. A 1031 can not do the same.
One of the benefits of a 1031 is that if you keep transacting one after another, you can enhance your wealth greatly. But at some point, when the time comes and the property owner wants to sell and doesn’t want more real estate, now you have a tax problem. Most property owners may not realize that for tax purposes, you must calculate your taxes based on the basis of the first property and not the last. So, if you paid $100k for your initial property and were able to sell your last property for $5 million, first I would say congratulations on a job well done and then I would tell you that your taxable gain is $5 million less $100k so you would have a capital gain of $4.9 million. Uncle Sam and the state you live in will thank you.
But wait, Is that John Wayne riding to the rescue? No, just our trust again. Sorry! What if by using our trust as a 1031 Exit Strategy, you could defer those taxes in the example above and retire and generate a larger lifetime retirement income based on $5 million than if you paid taxes first. WE are a great opportunity to exit from a 1031.
Real estate is a great way to accumulate wealth but that can create another tax concern that this administration is hoping to benefit from and that is the federal estate tax. If you have a large estate that will be subject to potential federal estate tax, our Section 453 proprietary trust can take the property out of the estate to potentially reduce the family’s federal estate tax burden. A 1031 can’t help at all with the federal estate tax.
Imagine this scenario. Four partners want to sell a property they all own. The problem is that 2 of the older partners want to sell and defer taxes and the 2 younger partners want to sell and go to Vegas, not necessarily a bad strategy. Unless they are all on the same page, they will not sell. Problem solved. Unlike a 1031 where all the partners must agree to defer taxes, we can provide each partner with his/her own solution. The two partners that want to defer taxes can each set up our trust and the 2 partners that want to take the money and run to Vegas can do so on one condition they take me with them. Hey, it was worth a shot.
There are numerous other opportunities that out trust can provide that a 1031 can’t and possibly the best reason is diversification. Quite often, when someone wants to sell and retire, they get bombarded by Qis that they can transact a 1031 and use a Delaware Statutory Trust as their replacement property. A Delaware Statutory Trust is a horrible retirement solution for too many reasons to discuss for the moment. The main reason however is the lack of diversification when dealing with retirement income. Any good investment professional would never put all the retirement assets into one basket but that is exactly what a Delaware Statutory Trusts does. I will go into more detail in another blog article but again, a Delaware Statutory Trust is not a good replacement property for a 1031. However, our trust is a great opportunity to diversify because you can invest in stocks, bonds, fixed income, guaranteed insurance contracts, REITs and numerous other asset classifications AND the diversification can be modified whenever necessary.
I can continue but I believe that’s it’s clear that our trust with a 25- year track record of successfully deferring taxes roughly 3000 times is a better option to defer taxes and will stay untouched by the current administration. Our next conversation will touch on the other 3 ways that this administration is trying to destroy the rural markets. Talk with you soon.
by David Fisher
David Fisher is the founding partner for Creative Real Estate Strategies, a firm dedicated to helping their clients buy and sell real estate in the most tax efficient manner through cost segregation, tax credits or deferring taxes through our Section 453 proprietary program.