Case Studies

Problem

A real estate investor who owned a trust that owned a mixed-use Class B commercial property wanted to sell his property for $4.3 million. While the property was in a good location, its age and configuration usually resulted in occupancy by lower credit tenants. This limited income available, which in turn made it challenging to make improvements or repairs which would have attracted tenants willing and able to pay more in rent. Even after adjusting for his basis, he was projected to have a $2.2M taxable gain. Because of the gain, his calculated federal tax was nearly $600,000 including the Net Investment Income Surtax. Since the Trust was domiciled in a high-income tax state like New York, his projected state tax was an additional $200,000. This total tax bill worked out to an effective tax rate of more than 33% on the sale.

Tax Wealth Network Solution

After completing a Pre-Sale Tax & Income Analysis before the property went into escrow, we identified several options for the client. These included a structured installment sale with guaranteed annuity payments and use of certain non-grantor trusts. Ultimately, the client chose to defer the capital gains using a 1031 Exchange into two different fractional ownership Delaware Statutory Trust (DST) properties. He was able to replace his property with better ones in highly desirable and growing locations, defer the gains, and acquire interests in two Class A tenant properties (a distribution center and a multi-tenant commercial campus, both located in the Southwest) occupied by Fortune 500 tenants. The cash-on-cash rate of return on his investments increased to more than 5%. And by deferring the tax, he had more income because he could invest nearly $800,000 more into these properties.