When selling property, there are 4 ways to receive the proceeds. The 4 ways include cashing out, a 1031 exchange, owner financing and an installment sale. All 4 come with potential concerns. For example, when cashing out, taxes must be paid immediately on the proceeds. The client may desire a 1031 exchange but as we know, sometimes exchanges fail and become a taxable event. Owner financing provides an income stream to the seller but the buyer may decide to pay off early and that creates a taxable event the seller may have hoped to avoid. An installment sale also provides pitfalls because the new owner may have a change in circumstances during the installment time period and may decide/be forced to give back the property. Then the seller has to start over and resell the property.
However there is a 5th option that brokers need to be aware of. That 5th option is a Deferred Sales Trust. The DST is a great opportunity that can enhance all of the options a seller has to receive proceeds. The DST is a trust that allows the seller to defer capital gains and other taxation on the sale of highly appreciated real estate for as long as the seller would like. Real estate properties can include land, ranches, farms, investment properties, commercial properties, a primary residence or a vacation home. Crops, livestock, timber or an agbusiness can also be sold in the trust.
Here is how the DST can enhance the other 4 options when the seller receives sales proceeds. First instead of cashing out and paying 15%-30% immediately in taxes, defer those taxes by using the DST. The proceeds can still be invested within the trust in the same manner that the seller would have invested outside the trust. However because the taxes are deferred, the seller is able to leverage the entire amount of proceeds to provide a larger cash flow from the trust. For example, $1,000,000 of proceeds in the trust invested @6% generates a $60k a year in income. After tax proceeds of $800,000 invested outside of the trust invested@ 6% generates $48k a year in income. Why wouldn’t someone want to invest in the trust?
The next option is a 1031 and as we are all painfully aware, not all exchanges are completed and that causes an immediate taxable event. A top notch qualified intermediary like Andy Gustafson at Atlas1031 can provide the proper wording to the client that will allow Atlas1031 to send proceeds to the DST should for whatever reason, the exchange cannot be completed. Thus, the DST acts as Plan B and since the seller does not have constructive receipt of the proceeds, the proceeds are not immediately taxable. But it gets better. The seller still has an opportunity to buy more real estate. Because there is no longer an exchange, the seller no longer has to jump through the IRS 1031 regulations and can now buy whatever property he would like whenever he likes. But it could get even better. When looking for financing, the proceeds in the trust might be used as collateral rather than the new property which might encourage the lender to give your client a better interest rate. So, let’s assume that the trust generates a 6% return and the interest rate on the loan is 4%. The income from the trust should be more than enough to service the debt service AND the trust owner still receives 2% from the trust. Everyone wins.
As far as owner financing and an installment sale is concerned, the DST solves the concerns associated with both and is probably a better alternative in almost every case. The only time that a DST probably would not work with an installment sale or owner financing is if the buyer doesn’t have the ability to buy the property outright.
There are numerous marketing opportunities utilizing the DST. For example, how often have you met elderly clients that would like to sell their property and move several hundred miles closer to their grandkids. An exchange doesn’t work and if they sell, there will be several hundred thousand dollars in taxes that they don’t want to pay. The DST may solve those problems and help you make a sale where there may not have been one otherwise.
If a potential client is concerned about finding a replacement property in an exchange, you can offer the DST as Plan B and there’s a real good chance that you will be the one that the potential client chooses to work with if there are several brokers involved in getting the listing.. Another opportunity involves a property with a lot of debt and little basis. If the property is sold, paying off the debt and taxes will leave nothing for your client and he may actually have to write you a check for your commissions. Why would he let you sell his property? If you introduce the DST, there is a way that not only can he sell the property but do so in a way that will still leave him with the proceeds in the trust which can defer his taxes but also provide an income stream to pay off his debt. He is in a much stronger financial position and you not only make a sale but you also get PAID when there would not have been a sale to begin with.
Now, consider the following. You are talking to a potential client that is interested in buying farmland or a timber property for income. Now, I will admit that I don’t know all of the intricacies of taxation in some of those instances but let’s assume that capital gains taxes are involved. The prospect is trying to decide which broker to use. You show him how the DST can help him defer taxation on the income from the timber or crops and guess who gets the business. You do.
Consider this one final example. A client tells you that he is going to be giving some property to a charity whose mission he feels strongly in through his will when he passes on. That’s great but there is no selling opportunity. Wrong. Consider telling him this. Mike, if I can show you how both you and your charity will be better off by letting me sell the property for you now rather than waiting until you die and giving it in your will, would you be interested in discussing that idea. The idea involves the DST and don’t hesitate to get your listing agreement ready because he will love your idea.
A famous Hollywood actor once said, “I’m proud to be paying taxes in the United States. The only thing is-I could be just as proud for half the money.” All he had to do was call you.
This content may not be used or reproduced in any manner whatsoever, in part or in whole, without written permission of LANDTHINK. Use of this content without permission is a violation of federal copyright law. The articles, posts, comments, opinions and information provided by LANDTHINK are for informational and research purposes only and DOES NOT substitute or coincide with the advice of an attorney, accountant, real estate broker or any other licensed real estate professional. LANDTHINK strongly advises visitors and readers to seek their own professional guidance and advice related to buying, investing in or selling real estate.