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Madison Capital Investments works with real estate investors like you on a daily
basis, and as a result, we possess an extreme admiration and respect for you.
Having been in the real estate trenches ourselves, we understand and
appreciate what it takes to acquire and own either one piece, or a portfolio, of
real estate outside of your personal residence.
In many cases acquiring and owning investment real estate is a considerable amount
of time-consuming, hard work without an immediate payoff. So when we see
investors who have acquired investment properties and built wealth through real
estate, we always have a high level of respect for them and their
accomplishments.
One question all investors should continually ask is: "What are my options?"
The reality is, once investment real estate owners have accumulated equity in a
property they have 6 options:
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1. |
Keep the Property |
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You can keep your property and either actively
manage it or hire a management company to manage it for you. This option is
the one everyone who invests in real estate knows and understands clearly.
However, there usually comes a point when the owner becomes tired of the
toilets, tenants and trash, and begins to look for other options to either
liquidate or move into a more passive ownership position.
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2. |
Sell the Property and Pay the Gains Tax |
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While this method is often used by real estate
investors, it is not necessarily the best option; and often is done
without a full understanding of other available options.
See: The Tax Problem
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3. |
Shelter the Tax Gain with Deductions |
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Another option you have is to
shelter your capital gains, the same as
sheltering your ordinary income with either tax deductions or tax credits.
There are many fine investment professionals who can advise you on tax
deductions or tax credits. It is up to you to judge the risk of those
investments your advisor recommends.
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4. |
Installment Sale |
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Another option is to sell your real estate and
receive an installment note; but this
could be the worst tax choice of all. The result can be paying, perhaps, triple
taxes.
First of all if you have a mortgage over basis
situation, that will be taxed as ordinary income in the year of the sale -
whether you take any sales proceeds or not. This often come as a complete
surprise and the federal tax rate on ordinary income may be 34%.
Also in the year of the sale, you will have to pay the 25% tax due on the
recapture of the depreciation, which may be more than the note and entire
down payment. The only tax that is deferred with an installment note is the
15% tax on your appreciated gain.
Next, while you and your spouse are alive, you will pay your capital gains
and state income taxes each year in which you receive a
note payment; and then, when the
surviving spouse dies, your estate may owe estate taxes on the notes
remaining unpaid balance. Your heirs will inherit the remaining notes but
they will continue to pay the capital gain taxes as they receive each note
payment.
An installment note does not get a
stepped-up basis at death. The combined,
potential, triple taxation on an installment note could exceed 70%.
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5. |
Put the Properties into a Trust |
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The fifth tax option is to defer capital gains
using an irrevocable trust.
One trust that was popular and effective for sheltering real estate gains
was the Private Annuity Trust. However,
recently the IRS directly addressed these trusts and determined that going
forward they were no longer a viable method for sheltering capital gains.
The most popular trust remaining for real estate investors is the
Charitable Remainder Trust. These can be
set up with an attorney. We recommend you consult with a trusted professional
who is experienced in Charitable Remainder Trusts to determine the options
for your specific situation.
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6. |
Tax-free 1031 Like-Kind Exchange |
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With investment real estate there are two ways
to employ a 1031 Exchange.
The first is to find, finance and manage all of the replacement properties
yourself.
Or secondly, if you want to make your life less complicated you could
purchase part of a bigger, better property that would not normally be
affordable on your own. A property that should have better economies of
scale - enough to afford professional management. This can be done by
co-participating with a professional real estate company as a
Tenant-In-Common (TIC) investor. The
real estate company (sponsor), as perhaps the largest investor, manages the property
with an owners motivation - like your own.
The 1031 Exchange rules are similar whether you
purchase all of something or part of something. |
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