I spoke recently with Eugene Page, President of Optimal Real Estate, Inc., a commercial real estate brokerage firm in Los Angeles. With more than 30 years’ experience helping investors buy and sell commercial properties, he offers unique insights into how best to sell real estate. He gave me a synopsis of the Los Angeles marketplace which could easily be true for any major U.S. coastal market.
“It is very common to be asked, ‘Do you have any good deals?’ In today’s market I must base my answer on who asked the question. If the caller wants to buy property, there are currently very few, if any, good deals. If, however, that person wants to sell his or her property, my response is an easy one: It’s a great time to sell! Pricing for commercial properties today is currently extremely strong.”
Puzzled, I asked, “Well, if there is such a vibrant market to sell property, why wouldn’t there also be one for those who want to buy?” Page explained it this way. “Even with this active market, the greatest challenge is persuading owners to sell, for two reasons. First, the owner is trying to sell at the top of the market and sometimes they miss it. Secondly, because cap rates are so low right now (as low as 1%) it is very difficult finding a property that makes sense for them to buy, especially if they have to reinvest the sale proceeds into a new property and close escrow within 180 days.”
Page was referring to the Starker 1031 exchange rules that require a property of equal or greater value to be purchased within 180 days to retain capital gains tax deferral benefits.
“A real disconnect exists in the marketplace right now because of this disparity,” Page said. “and it also creates two added challenges for those who want to sell. One is that their preference is to park the money and wait to buy when the cap rates become attractive again. The second challenge are the capital gains taxes that would be triggered by selling the property.” So, how can sellers solve the tax issues and at the same time position themselves to buy a new property when they want and at the right price?
How Best to Defer Taxes When Selling Appreciated Commercial Property?
Sellers of investment property usually turn to the 1031 exchange, thinking that it is their only option to defer taxes due. But the 180-day rule restricts their flexibility, as Page noted.
A better tax deferral method exists, though. They should consider a lawful way that allows the Seller to walk away from escrow closing with NO immediate capital gains taxes due and still receive a tax-free lump sum of money that is nearly equivalent to the sale proceeds. Unlike a 1031 exchange, the seller is not required to declare properties to be purchased within 45 days after escrow closes; nor do they have to comply with the 180-day rule to close escrow. The seller simply sells the property, defers the taxes for decades and receives at close of escrow a lump sum of tax-free cash to invest however and whenever they choose. Structurally, this is accomplished by coupling a monetization loan with an installment sale. Let’s compare these two planning methods.
Section 1031 Sale/
Coupling a Monetized Loan with an
|Assets Eligible for Sale||Commercial and other investment real estate||Any appreciated capital asset (property, business, securities)|
|Timing||New property identified within 45 days of sale of old property, and purchase closed within 180 days.||No time limit on when (or if) to invest funds received at close of sale of old asset|
|Assets Eligible for Purchase||New property must be real estate intended for commercial or other investment use.||No limit on how to invest funds received at close of sale. Seller is free to create an investment plan that exactly meets his or her objectives and financial needs.|
|Taxes due on appreciation||As long as new property is equal to or of higher value than the old property sold, taxes are deferred until new property is sold.||Taxes are deferred into the future. New property bought, if any, has a new cost basis of the purchase price.|