Provided by Brian Rogers, Certified Financial Planner at AEGIS Financial

We identified several options:

1. Pay the tax.

2. Complete a 1031 Exchange into another local piece of real estate.

3. Complete a 1031 exchange or to multiple Deferred Sales Trusts (DST), in which each held one leveraged property.

4. Complete a 1031 exchange program resulting in owning a Real Estate Investment Trust (REIT) after two years.

Each option had various advantages and disadvantages, which we discussed with the client.

Pay The Piper

The outright sale and payment of the taxes would have given the clients maximum flexibility in their future investments. However, due to the property’s debt, the clients would have had approximately 65% of the sale proceeds go to the Federal and State governments to pay the Capital Gain and Depreciation Recapture taxes. Being left with about one-third of the sale proceeds would have prevented the clients from enjoying the lifestyle they have been accustomed to enjoying.

1031 Exchange

A 1031 exchange is a transaction in which the IRS allows real estate investors to liquidate one investment and reinvest the proceeds into another investment. By completing the 1031 exchange, the investor can continue to defer the taxes due. Then at death, these investments could qualify for a step-up basis, resulting in the surviving spouse or the heirs having little to no tax owing—any sale proceeds not reinvested through the 1031 exchange become taxable. Therefore, in our client’s case, the debt on the property also had to be considered.

Due to the property’s value, the local real estate market offered limited options. Additionally, the required deadlines set by the IRS made this option difficult, as local properties were not targeted before the sale. Finally, a local property would not fulfill the goal of exiting the role of landlord.

The option of investing in individual DSTs accomplished the deferral of taxes in addition to generating income from dividends. However, the selection of properties was once again challenged by the debt held on the property because specific DSTs had to be selected to cover all the equity and debt of the property. In addition, the individual DSTs are illiquid investments that the investment manager will eventually sell, forcing another 1031 exchange or the tax to become due at some future date. Finally, the individual DSTs also carried the risk of having a significant portion of the client’s net worth tied to one piece of property.

The final and preferred option was a multi-step process that resulted in the clients owning shares in a multi-billion-dollar REIT that held properties across the US and spread over various sectors and industries. This option resulted in lower dividend yields and a lack of liquidity for the first two years. However, beginning in year three, liquidity and dividend yields improved more income from the dividends, and they could partially liquidate REIT shares. The sale of the shares of the REIT would result in a portion of the deferred capital gain being realized, but the tax would be significantly lower because not all gains were realized in one year.

At AEGIS Financial, we are not swayed by product commissions or incentives. Instead, our interest is in finding the right solution to your problems. By laying out various options and educating them on the advantages and disadvantages of each option, we were able to help our clients defer a significant tax bill while providing the income to fund their retirement.

Provided by Michael Donnan, CLTC, FIC Wealth Manager at AEGIS Financial

Things to Know:

• Tax Day Alert: Mark your calendars for Monday, April 15th, 2024. This is the deadline for contributing to your IRA and Roth IRA for the tax year 2023.
• Roth Contribution Limits: In 2024, the Roth contribution limits stand at $7,000 for those under 50 and $8,000 for those 50 and older.
• Enhanced Employer-Sponsored Plans: If you have a 401(k), 403(b), or 457 plan through your employer, note that the new maximum contribution limit for 2024 is $23,000. Individuals aged 50 and above receive a higher limit of $30,500.

Things to Review:

• Estate Planning Checkup: Review your estate planning documents. If they are older than 8 years, it’s advisable to consult your attorney and assess whether updates are necessary.
• Property Ownership Consideration: If you own property in your name, consult with your attorney about the potential benefits of adding a Transfer On Death (TOD) Deed. This can streamline the property transfer to your named beneficiaries, bypassing probate.
• Tax Efficiency Strategies: With anticipated tax rate increases in 2026, consider the advantages of Roth Conversions as a strategic financial move that can benefit both you and your heirs.
• Charitable Giving Tactics: For individuals aged 70 ½ who donate to charities or churches, explore the benefits of utilizing a Qualified Charitable Distributions (QCDs) strategy. This approach allows you to contribute directly from your IRA, bypassing taxes. If you’re in Required Minimum Distribution (RMD) status, this tactic aids in meeting your distribution requirements without incurring taxable consequences.

As you plan for the upcoming year, these insights and reviews can contribute to a more informed and financially resilient future. The AEGIS team is ready to assist you in navigating these intricate financial considerations and give you peace of mind in your financial journey.