DON’T Use A 1031 Exchange! Use This Instead for Deferring Taxes with Brett Swartz
If you own property that you’d like to put on the market but don’t know if it’s a good idea, you might consider using the “deferred sales trust.”
If you’re starting in real estate or a seasoned veteran who wants to take this strategy to the next level, the deferred sales trust is the way to go.
It’s an effective way of deferring taxes on real estate investments.
This alternative real estate investing strategy will allow you to buy and sell properties as often as you like, but it comes with a couple of necessary restrictions.
Let’s look at this strategy’s pros and cons and how it can help you buy and sell real estate more efficiently.
What is a Deferred Sales Trust?
A deferred sales trust is an investment strategy that allows you to delay paying taxes on the appreciation of your real estate investments for as long as you like.
You usually have the option of deferring taxes on the appreciation until you cash out, or you can choose to start paying taxes on the deferred appreciation immediately.
This is done by establishing a trust to hold your real estate investments.
The trust will assure you that the appreciated property will be put back into the exact location and that no one will profit from the change until you sell the property.
This is often done with an endowment contract, where you put money into a trust that will receive income in the future and promise to keep making payments until the trust is fully depleted.
You can also use a hybrid strategy, which will allow you to defer taxes on some of the gains, and still make timely capital gains tax-free.
These strategies are called partial expensing because you can only expense certain costs in the year you earn the income.
Pros of Using a Deferred Sales Trust
No capital gains tax. This is the most significant pro of all. As soon as you realize any profit from the sale of real estate, you can immediately pay taxes on it, as well as interest and taxes on the gain from other investments.
This is a massive benefit if you invest in real estate as a primary income source. But, unfortunately, the longer you wait, the larger the tax bill will eventually be.
No income tax due in TAX YEAR. Another significant pro of this strategy is that you’re not required to pay taxes on the gains from selling real estate in any particular year.
As soon as you cash out, you’re finished with that investment and will have to start over again from scratch. So defer taxes on the appreciation.
Although you won’t owe any taxes on the gain from the sale of your real estate until you sell, you will still have to pay taxes on the appreciation that occurs on other investments while you wait.
This can be a significant tax burden if you’re paying taxes at your current annual rate of approximately 39%.
Pay no capital gain tax.
Once you decide to sell, you don’t owe any income tax on the gain from selling your real estate. This is a significant pro because you don’t owe any taxes on the gain until you cash out of the sale.
As soon as you do, you owe taxes on the total amount, which you can either pay or defer.
Another pro of this strategy is that you won’t have to deal with as many steps as you would with a conventional sale and purchase. Instead, you have to write a check and cash out.
Cons of Using a Deferred Sales Trust
Terms and conditions. One of the biggest cons of the deferred sale trust is that you can’t cancel the contract. Once you sign a contract to buy property, you can’t simply change your mind and back out of it.
While this may work in some cases, especially if you’re buying a foreclosed property, setting up a deferred sale trust can be challenging and time-consuming.
And if you have to cancel the contract more than a year before closing, the property will lose all its appreciation, and you’ll have wasted your money.
No income tax is due until you sell. Although you won’t owe taxes on the gain from the sale of your real estate until you sell, you will still have to pay taxes on the appreciation that occurs on other investments while you wait.
This can be a significant tax burden if you’re paying taxes at your current annual rate of approximately 39%—a long payment cycle.
One of the cons of this strategy is that you’ll have to pay taxes each year on the appreciation of your real estate investments.
This is usually a significant tax burden if you have other bills and can’t afford to pay them all simultaneously.
When to Use a Deferred Sales Trust
The best time to use a deferred sales trust is during your taxable years. This is when you’re required to pay taxes on your income, so you’ll have the slightest pressure on your budget.
If you’re conservative with your investing and have built up a large amount of cash, you can wait and enjoy the income without worrying about paying taxes until you sell.
However, if you’re like most people and want to start putting some of your money into stocks, bonds, and other investments as soon as possible, you may consider using a deferred sales trust.
The ability to defer taxes on the appreciation of your real estate investments will allow you to hold onto your investment longer and make a larger profit overall.
How to Use a Deferred Sales Trust
The easiest way to use a deferred sales trust is to set one up for each real estate investment you want to hold.
For example, if you have two properties to hold, you can have a separate trust for each one.
However, it would be best to decide which one will be your primary residence and include it in your taxable year.
Once you’ve done that, the rest will be easy. You can transfer the money from the second trust to the primary one.
Where to Find Brett Swartz
Youtube, Podcast, Itunes : Capital Gains Tax Solutions
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