A number of tax trends are occurring in tandem with certain tax-deferral strategies.
It goes without saying that, all things being equal, having access to a larger pool of money offers you the chance of greater returns. That’s why strategies to defer tax payments are so perennially popular, as a way to grow investments and businesses, larger and faster.
With that in mind, a number of tax trends are attracting renewed attention and should be of interest to you:
So, what are the strategies being used in tandem with these tax-deferral trends?
In its most basic form, Internal Revenue Code (IRC) Section 1031 allows owners to exchange one piece of real property for another, without triggering the capital gains tax. By reinvesting in essentially the same type of enterprise, as part of an integrated transaction, owners can defer the tax they would owe on any appreciation in value.
They can also exit out of one particular asset and redeploy their capital into another property of a similar class. This enables them to capture value, take advantage of new opportunities and hedge against potential risks they may see on the horizon.
The sticking points. In order to qualify for a 1031 exchange, “like kind” properties must be acquired and disposed of in accordance with strict rules and in a set time frame. In terms of managing the transaction, you’re permitted to proceed in three ways, by making use of either 1) a simultaneous swap, or: employing the following two methods taking place within a defined window of time: 2) a deferred or 3) a reverse exchange, if you identify the property you’d like to purchase first.
What’s important to remember here is that unless strict time lines are followed, the entire transaction may be taxed. The basic time frame is listed below. The time line starts from the date of sale, and there are no extensions granted for any reason other than a “federally declared disaster”:
UPREIT stands for “umbrella partnership real estate investment trust.” While the term may be puzzling, the main point to remember is that an UPREIT enables you to trade your ownership stake in the real property in question for an operating partnership (OP) or limited partnership (LP) stake in a REIT; this can later be converted to either REIT shares or cash.
It’s important to note that receipt of the OP or LP shares isn’t considered a taxable event, but tax will be incurred if and when you decide to convert them into REIT shares or cash.
Because REITs are mainly concerned with institutional-quality property, this solution may not be appropriate for all investors. If you’re looking to diversify and remove yourself from day-to-day management, however, an UPREIT may be an appealing option and a viable alternative to a 1031 exchange.
A few caveats. Once you’re locked into the REIT structure, you no longer retain any control over the sale or disposition of your former property. This could happen at any time, and has the potential to trigger a taxable event, in the form of capital gains or a recapture of any depreciation. And since your ownership is in the REIT rather than in real property, you don’t have the option of attempting to defer through an exchange, nor can you exit the UPREIT structure without incurring a tax.
However one positive here is your option to convert your shares gradually so as to lessen the impact and avoid having to pay all at once, as in the event of a sale.
How to decide which is right for you? Consider the following questions in consultation with your tax and legal advisor:
While there’s much more to consider, this overview should provide a starting point for exploration of the potential benefits of these strategies for tax-deferral.
It’s important to remember that while these are powerful tools for deferral, they all end the same way: sooner or later, you or your heirs will wind up with a tax bill. As always, it’s important to plan these strategies around the long-term goals for both your family and business.