Though the title may be a bit exaggerated. Depending on your circumstances and what you are looking to do, it can be possible to structure the sale of a vacation property into an almost tax-free long-term hand-off real estate investment.
Below is some additional information about using a 1031 and Delaware Statutory Trust to handle the sale of a vacation home. This real estate investing strategy definitely requires professional assistance.)
For some insight into selling a vacation home and turning it into a long-term investment, check out this article from Ian Lazarus, sjbeachhomes.com, (@ShoreHomeAgent) has an excellent article on ActiveRain, Get out of the Landlord Business Tax-Free.
Fast forward to a market that has put the real estate crash in the past, on the east coast, we have a large group of aging baby boomers who have a similar challenge as the farmers that came before them…but this time it’s highly appreciated rental property on the New Jersey and Delaware beach, or even those with high rental income oceanfront homes on the Outer Banks.
For those unfamiliar with the IRC 1031 like-kind exchange strategy, the time restrictions and other potential tax-triggering pitfalls seem far too daunting to even consider. For those well seasoned in the art of 1031 exchanges, it no longer seems like a viable strategy given their desire to start downsizing their properties, which would trigger a tax liability.
Or, they just don’t want to be a landlord anymore. Unfortunately, most owners think they have only two choices; a) bite the bullet and keep your property or b) sell and pay taxes, sometimes upwards of 50% of your sale proceeds!
If you have ever considered selling your investment property at the shore, but something has stopped you in your tracks, please consider reaching out to our team to discuss your specific situation. We can bring a team of real estate, financial planning, tax, and legal advisors to you or we are happy to work in tandem with your existing advisors. Either way, knowledge is power. And power leads to a lifetime of financial freedom.
Let me explain using a recent case I helped solve. John Walton (name changed to protect the innocent) has owned a shore home for almost 30 years. His adjusted cost basis after depreciation is almost zero.
His expected sales proceeds, after debt pay-off, was supposed to be about $2,000,000.
But, he was expecting to have to pay total taxes of $940,000! For a retired guy to generate income on his after-tax proceeds of $1,060,000 at today’s rates, he could only expect about $42,400 per year.
That’s terrible considering he was collecting net income of over $100,000 before he sold. We encouraged him to consider a 1031 exchange, but rather than finding another property to privately own, we identified two apartment complexes professionally-managed and owned within a Delaware Statutory Trust (DST for short).
And, by owning beneficial shares of this DST exactly matching his sales proceeds and with a loan-to-value ratio higher than his shore home, we deferred 100% of the taxes due. More importantly, with 100% of his proceeds invested in the DST, we were able to generate a tax-favorable income of $110,000 (5.5% yield) and eliminate all the hassles of being a landlord.
C. Grant Conness co-founder of Global Wealth Management & co-host of the “Global Wealth Radio Show” who also happens to be an Investment Adviser Representative at Global Financial Private Capital which is one of Forbes’ 2013 Top 50 Fastest Growing RIAs and an insurance professional has an excellent article:
C. Grant outlines the same concern Ian does in the above article. How to divest of a real estate investment without paying a high capital gains tax.
There are some guidelines that you have to follow. You must set up your 1031 prior to closing on the sale, and your sales proceeds go to a third party, called an accommodator or a qualified intermediary, to hold. From closing, you have 45 days to identify the property you’re going to exchange into. And then you have six months to close on the property you identified. If you do all that, you’ve accomplished a successful 1031 Exchange. But until 2004, you were still replacing one property with another — so, like it or not, you were still a working landlord.
More recently, Revenue Ruling 2004-86 determined that a Delaware Statutory Trust qualified as real estate and, as such, could serve as a replacement property solution for 1031 Exchange transactions. If you were tired of managing a property yourself, you could, instead, acquire a fractional or percentage interest in a DST, and become a part owner in a much larger real estate investment — a 300-unit apartment building, a grocery center, medical office building, etc.
So now instead of Mr. and Mrs. Smith as your tenants, calling you to come fix the garbage disposal, Walgreens or CVS is your tenant with a corporate lease. It’s a more hands-off way of owning income-producing real estate that’s especially well-suited to retirees. A dozen or so fairly large companies put together deals for investors to exchange into that are professionally managed and pretty much turnkey.
It could be an interesting option for anyone who owns a vacation home that has significantly appreciated since 2008. Especially those who are retiring or already retired. Being able to roll the money over from years of owning a home somewhere on the Jersey Shore like Ocean City, Sea Isle City, Avalon, or Stone Harbor to owning something that offers a more stable investment income that is also hands-free and doesn’t require you answering a tenant about why the air conditioning doesn’t work on 100 degree days.
With the average home prices up and down the East Coast on the rise, now may just be the time to buy a brick apartment building and not have to worry about things like hurricanes or seasonal changes in vacationing.