Simply put, tax reforms and other changes have an impact. How much profit is taxed on commercial real estate properties? As a result, it’s critical to be aware of any tax benefits that derive from the sale of a property to gain more control over significant capital gains.
Tax burdens reduce by using strategies such as 1031 Exchanges or a Delaware Statutory Trust. Of course, tax-deferred exchanges like these aim to allow for a significant gain without incurring a tax penalty.
Let’s get into the specifics.
Note: These tax-saving mechanisms may differ by state or county, so investors should be aware of any applicable regulations that are property-specific to the state or county.
Exchange 1031
A 1031 Exchange is one of the well-known tax deferral strategies. It involves an investor selling a property and reinvesting the proceeds in a like-kind property that meets specific criteria. When done correctly, the investor avoids paying capital gains tax.
The SPECIFICS:
- It only applies to investments of equal or more excellent value.
- Foreign real estate is not a viable option.
- To qualify, you must be identified within 45 days of closing and close within 180 days or by the taxpayer’s return deadline (whichever is earlier).
- Tip: If a 1031 Exchange is completed near the end of the fiscal year, it may be beneficial to request an extension on the taxpayer’s return.
Delaware Statutory Trust (DST)
Although Delaware Statutory Trusts are not a new concept, they may become a preferred investment vehicle for both passive and direct/non-1031 Exchange investors, depending on current tax laws. It is due to the typical structure of DSTs, which are not taxed at the business organization level.
The SPECIFICS:
- DSTs must not be formed in Delaware to be legally recognized as business trusts.
- It is a separate legal trust derived from Delaware Statutory Law, qualifying it as a tax-deferred exchange under IRS Section 1031.
- It allows for the ownership of 100 percent of the fee simple interest and may allow up to 100 investors (sometimes more) to participate as property owners.
Tenancy-in-Common (TIC)
Tenancy-in-common ownership enables individual investors to pool resources, obtain additional financing, and hold ownership interests without having to take on property management responsibility.
The SPECIFICS:
- Each investor or co-owner has a fractional, undivided interest.
- Because TIC is recognized as a form of direct ownership, it may be 1031 Exchange-eligible.
- A total of 35 investors are permitted.
- Unlike in a DST, investors receive the deed to the property and typically form a single-member limited liability company (LLC).
- Unlike a DST, investors have equal voting rights and unanimous approval.
Opportunity Zones
The Opportunity zones are made for economically disadvantaged areas across the United States through the use of tax cuts and the Jobs Act of 2017.
The SPECIFICS:
- When a property is sold, the investor must reinvest the proceeds within 180 days into a qualified fund that invests specifically in opportunity zone properties.
- To reap the tax benefits, investors must keep funds in the investment for a minimum of five years.
- To qualify for a tax break, it must be a significant capital gain (money from other sources would not be acceptable).
EXAMPLE OF INVESTMENT PROPERTY:
Single-tenant net leases for properties are still a secure investment. In 2019, 44% of STNL (Single Tenant Net Lease) buyers took advantage of a 1031 Exchange. This tax-deferred strategy frequently serves as an entry point for investors.
When it comes to investment properties, you’ll want to stay on top of any strategies that could help you reduce your tax liability at the end of the year. So, keep these points in mind if you want more control over your capital gains.
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