Image from Mark Kohler
If you’ve decided it’s time to cash out your real estate investments and no longer want to use Section 1031, it’s important to know what will happen with your taxes.
Generally, you’ll increase your tax liability when you sell your real estate investments, but there are ways to minimize it.
Don’t throw away the income you’ve earned through the years, carefully avoiding taxes with the Section 1031 exchange.
Here are three options to help.
Consider Charitable Remainder and Wealth Replacement Trusts
You must donate your real estate to a new charitable remainder trust to use this strategy. In addition, the trust must include instructions to pay you and your spouse income during your lifetime.
As a part of the trust, ensure the instructions state that the remaining balance gets donated to charity once both spouses die.
By donating the property, you get a charitable contribution deduction and don’t pay taxes on the full amount of the capital gains because you earn money in increments.
Finally, you should create a wealth replacement trust. This replaces the wealth of the charitable remainder trust when both spouses die. The insurance pays the proceeds to the insurance trust, and your heirs receive it.
Use Section 721
You can also donate the property to a partnership using Section 721. When you donate the property to a partnership in exchange for an interest in the partnership, you don’t pay capital gains.
Essentially, you donate the property to a real estate investment trust, and the real estate investment company manages it, giving you a piece of the company. As a result, you avoid taxation and receive periodic distributions from the REIT’s income.
You can sell the property as an installment sale, with you operating as the lender. Instead of collecting the property’s entire sales price upfront, you receive payments in installments.
In exchange for the loan, you charge the buyer an interest rate higher than you’d earn on any investment. In addition, you pay taxes on the income as you earn it rather than all at once.
The money you earn will be part taxable and part nontaxable. The principal payment is 50% taxable and 50% nontaxable, plus the interest earned.
If you’ve owned real estate for many years and have strategically conducted Section 1031 exchanges to avoid taxation, it’s important to know what to do when you’re ready to sell the property.
When it’s time to give up the real estate, explore your options to avoid excessive taxation and all the hard work you’ve done through the years.
If you have questions about how to sell a property when you’re done with the Section 1031 exchanges, contact me, and let me walk you through it.