THE 1031 EXCHANGE INSTITUTE

Defer Capital Gain Taxes

We talk a lot about deferring capital gain taxes generated from the sale of real property, whether it be residential or commercial property, and we often defer the payment of the capital gain taxes and depreciation recapture taxes on the sale of real estate through a 1031 tax deferred exchange.

However, the 1031 tax deferred exchange requires that you sell investment real estate and acquire like kind replacement real estate. What do youdo when you do not wish to acquire any replacement property but you still want to defer the payment of your capital gain taxes over a period of time?

This is a common problem. You may not want to acquire like kind replacement property or you may not be able to acquire like kind replacement property in order to defer the payment of your capital gain taxes under Section 1031. 

You probably do not want to get hit with your capital gain taxes all at once in the year you sell your real estate, business interest or company, either. That would be quite a lump sum of taxes that would be due in one year.

Sale of Business Interest

It often involves the sale of the investors business or company that they have owned and run for many years. They are now interested in disposing of the business and are faced with a huge capital gain tax resulting from the sale of the business.

I am working with a client right now that is selling a gas station or service station. He wants to get entirely out of the business. He does not want to reinvest in real estate and does not want to acquire another business of any kind, so deferring the payment of his capital gain taxes on the sale of the gas station using a 1031 exchange will not work for him.

Tax Deferred Solutions

There are any number of tax deferred solutions that might work for this client. He or she should consider a variety of income tax strategies, including:

• Selling and paying the taxes or cashing out
• Selling and carrying back the note (seller financing)
• Selling and completing a tax deferred exchange under Section 1031
• Selling through a Deferred Sales Trust
• Contributing the property into a Charitable Trust
• And more sophisticated options

Cashing out is not terribly attractive since you incur 100% of your capital gain taxes in the year in which you sell your business.  The seller carry back or seller financing option is risky because the buyer could default and you run the risk of having to take your business back.  The 1031 tax deferred exchange does not work well with the sale of a business because the like kind property rules for personal property are very restrictive.  The Charitable Trust options are permanent and therefor not really appealing.  The one remaining option that does seem to be appropriate is the Deferred Sales Trust. 

Deferred Sales TrustTM

This is where the Deferred Sales Trust might be useful and can really shine.  It allows you to sell your business interest and defer the payment of your capital gain taxes over a period of time that you negotiate up front with the trustee of the Deferred Sales Trust.  The Deferred Sales Trust should be reviewed with your tax and legal advisor before structuring or implementing.