"IRS Approves New Tax Deferment Program" - 1031 Exchange without a Replacement Property?

For years, investors have taken advantage of the 1031 exchange as a method to delay or defer capital gains taxes on the sale of an investment property. By completing an exchange, the investor can sell or dispose of an appreciated investment property, use all of the equity to buy a like-kind property of equal or greater value, defer the capital gains tax and leverage all of their equity into a replacement property. The 1031 exchange is one of the last great vehicles to build wealth and save on taxes.nnThere still exists the investors who do not acquire a replacement property. Maybe the next move may be difficult to find the right property. The specific time-frame or an undesirable market is not conducive to executing an exchange? That investor may just want to move on with life, dispose of the asset without a replacement, but still not pay all of the capital gains upfront. Is there a solution?nnThere was such a solution called the private annuity trusts (PATs) which could be used to avoid capital gains taxes by transferring the title of a property to a trustee prior to the sale. Once the trustee sold the property, the proceeds from the sale would fall into the trust and then payments would be paid to the beneficiary. Most often, the trustor and beneficiary would be one and the same, therefore allowing the beneficiary (the original title holder) a method to collect payments while avoiding any upfront capital gains tax. In the fourth quarter of 2006, however, the IRS ruled that PATs were being used inappropriately to defer capital gains and estate taxes and could no longer be used in this manner.nnThe deferred sales trust (DST) has become the replacement strategy for the private annuity trust. Very similar to the PATs, the deferred sales trust, recognizes capital gain, but it is deferred over a predetermined period of time that is planned in advance of the sale.nnHere is a breakdown of the process for a DST:n1- Private third-party company forms a trustn2- Owner sells the property to the trustn3- Trust and owner (beneficiary) put together an installment contractn4- Contract promises to pay beneficiary predetermined amount over an agreed period of timenn-------------------------------------------------------------nExample of DST vs. a Typical Sale (California)n-------------------------------------------------------------nAssumptions:nOwned for 8 yearsnPurchase Price: $ 2,750,000nnSale Price: $ 4,100,000nLoan Amount: $1,750,000nRecapture Depreciation $ 800,000nnBasis: $1,950,000nTaxable Gain: $2,150,000nn-------------------------------------------------------------nStandard Sale Transaction:n-------------------------------------------------------------nNet Sale Proceeds: $ 2,350,000n Federal Tax (15%) $ 322,500n State Tax (9.3%) $ 199,950nProceeds after tax: $ 1,827,550nnAnnual Interest of $ 146,204nn-------------------------------------------------------------nDST Transaction:n-------------------------------------------------------------nNet Sale Proceeds: $ 2,350,000nAnnual Interest of $ 188,000nn-------------------------------------------------------------nDST income difference of 22% or $41,796n-------------------------------------------------------------nn As you can see, the deferred sales trust can be a vehicle to defer taxes without having to acquire a new property and in the long run may actually be a more viable and lucrative choice than other tax deferment methods. To find out more information, contact a commercial real estate broker or tax professional in your area.