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  • By Eric Nelson, Woloshin Investment Management

Why you can’t get your prospect to list that property

Why can’t you convince your prospect to list their property with you? The highly appreciated property they’ve owned for years. You’ve told them about the great resources you have to market that property and secure the best price for them, and that now is the time to sell. Everything points to selling, yet they won’t do it. Why?

Well, the problem may very well be that they actually want to sell but are concerned about capital gains taxes draining their sales proceeds and depleting their wealth. The simple solution is a 1031 Exchange. But the very reason they may want to sell is their current ability to secure what they perceive to be an attractive price in an appreciated market. But, a 1031 exchange transaction will require that prospect to reinvest in replacement real estate in a very short period of time. In fact, they must identify their replacement real estate within a strictly enforced time period of 45 days from the date of closing or lose the opportunity for tax deferral under Section 1031. Reinvesting in real estate under these conditions could be counterintuitive to your prospect’s goals and, therefore, even a 1031 Exchange may not be attractive or useful. Well, a better solution for them may be The Deferred Sales Trust™. The Deferred Sales Trust™ has become a popular strategy for deferring capital gains taxes upon the sale of real estate and other highly appreciated assets. Like a 1031 Exchange, the DST can be used to defer capital gains taxes on real estate but, unlike a 1031 Exchange, it does not require that the taxpayer reinvest in like-kind property, thereby providing the opportunity for diversification of assets. Moreover, the DST can be used to defer capital gains taxes on other high value assets such as a taxpayer’s business, including goodwill, which is typically not appropriate for 1031 Exchange treatment.Here’s a simplified explanation of how the DST works:

The client sells their asset to a third party trust in a seller-financed transaction (in whole or in part) under IRC Section 453. In return, the taxpayer receives an installment note with a specified rate of return. The trust then sells the asset at the new basis (established under the sale to the trust) to the third party buyer. The result is that the taxpayer’s capital gain taxes are deferred under the installment sale rules and the relinquished property is sold from the trust, leaving the pre-tax proceeds to be invested within the trust in a manner that will secure the note principal. These investments can include a variety of investment vehicles including stocks, bonds, mutual funds, etc. The proceeds can even be invested in conventional real estate down the road. There is a good deal of flexibility in the way that a DST can be structured. The client can structure the note for income, growth, or both, and with additional planning can often be used to resolve estate tax exposure as well. Regardless of the goals of the individual taxpayer, though, it is crucial that the DST structure be implemented in advance of the closing on the sale of the asset that the taxpayer wishes to defer capital gains taxes on, and preferably in advance of a firm sales agreement.

Eric Nelson is a financial advisor for Woloshin Investment Management.

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