Owner doesn't like 1031 exchange - Posted by Iowa Laurie

Real Estate Investing Real Estate Law
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Posted by Frank Chin on January 30, 2002 at 06:34:20:

Hi David:

One of the big plusses with the NNN lease is the seller/lessor after collecting this intitial lump sum for the leasehold, still owns the underlying fee position. If he or his heirs are around at the end of the leasehold, the appreciation will be there for them to claim. The heirs would enjoy the stepped up basis at death as well.

Meanwhile, they have a lump sum to play with, and not worry about property management to boot.

There was a newspaper article about a wealthy investor who owns a brownstone here in Manhattan, NYC convicted of second degree murder killing his tenant in a lanlord tenant dispute. Some of these brownstones sell for $15 to $20 million.

The article reported said he “sold a leasehold to an investor for 7.5 million tax free.” Yes, it said tax free in the article, but I guess they meant capital gains tax free. The news article goes on to say that this is different than selling the property where he had to pay capital gains etc.

A relatively short leashold of this type goes for 30 years. The article didn’t go into the why’s. But I can see that the $7.5 million, even paying some taxes would go a long way providing for his family, and when he comes out of jail in some 20 or so years, he can reclaim the building plus the appreciation when the leasehold expires. Meanwhile he didn’t have to worry about managing the place from jail.

Properties in NYC had be doubling every 15 to 20 years. A 15 million brownstone would go up another 15 million while he’s behind bars. If this smart cookie gets out with good behavoir in 15 to 20 years, he’ll be making 1 million a year in jail.

Another variation of “making money while you sleep” and a good validation of the “buy and hold” strategy.

Certainly, a 1031 exchange is not going to solve this guys problem while in jail.

Frank Chin

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Owner doesn’t like 1031 exchange - Posted by Iowa Laurie

Posted by Iowa Laurie on January 28, 2002 at 18:53:24:

I have a flexible property owner that wants to sell a 4 plex (in good shape, fully rented) and a SFH, but doesn’t want to get hit with capital gains taxes. He is not interested in a 1031 exchange because he thinks he is too old (70’s).

Any suggestions on how I can help him?

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Go for a NNN Lease - Posted by Frank Chin

Posted by Frank Chin on January 29, 2002 at 10:25:12:

Hi Laurie:

Others gave you good advice. Installment sale and Triple Net Lease are the ways to go.

This older gentlemen wants to sit around and does not want to 1031 into another place, especially in the 70’s. Who wantts to clean, paint, evict tenants at that age.

With the installment sales, the seller pays the Capital Gains, but a little at a time.

Long Term Triple net (NNN) Leases are more common with commercial properties, but used in expensive residential brownstones here in NYC. The lessor collects a monthly payment, and you pay the taxes, insurance and does the maintenance.

Some older folks need the cash to do a thing a two meantime, but capital gains really scares them. In that case, you can pay the present value of the NNN lease in one up front lump sum amount and obtain a mortgage on the NNN lease. So for the seller (actually the lessor) he would receive a lump sum tax free dollars.

I wrote a post before about this method. Eventually, you might deal with the heirs of the older gentlemen, and you might be able to buy the underlying fee position of the property at a good price as it is now encombered by a NNN lease that you’re holding.

You’ll have to deal with the commecial loans department when you go for financing on NNN leases.

Frank Chin

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Re: Owner doesn’t like 1031 exchange - Posted by Brent_IL

Posted by Brent_IL on January 28, 2002 at 23:10:41:

I’d vote for the triple net lease with option approach. I’m not sure what age has got to do with a 1031 exchange. It’s cheaper, most of the time, to pay capital gains taxes than it is to pay the taxes on the same amount of ordinary income. It’s still a stepped-up basis for his heirs.

Another slightly more esoteric tax approach is a partial charitable donation of the real estate with you being the intended buyer from the charity. See http://www.donaterealestate.com/tax.html for ideas.

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Re: Owner doesn’t like 1031 exchange - Posted by David Krulac

Posted by David Krulac on January 28, 2002 at 21:30:17:

not paying capital gains tax and no doing a 1031 exchange does limit your options.

One compromise might be an installment sales agreement, where he would only pay the tax in the year that the income was received. that would defer some of the tax to later years.

If the owner lived in the property for 2 of the last 5 years he could take advantage of up to $500,000 tax free. If he doesn’t live there maybe he could move there for the next two years then sell you the property!

hth

David Krulac

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Re: Owner doesn’t like 1031 exchange - Posted by Robert (NC)

Posted by Robert (NC) on January 28, 2002 at 21:14:50:

I’m no expert, but maybe a tripple net lease ? that would give him time to figure out what he wants to do…

maybe lookinto him doing 100% owner financing ? I’m not sure if he would haev to take all the cap gains when he ‘sold’ even if he was owner financing…
I’m sure some of the experts on here can give better advice but those are the first 2 things that come to my mind…

happy investing…

Robert (NC)

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Two points, Frank… - Posted by David Krulac

Posted by David Krulac on January 29, 2002 at 19:55:35:

  1. The proceeds of a NNN would be ordinary income and not offset by any expenses since the tenant is paying the expenses. Therefore, proceeds of a sale would most likely be taxes at 20% while the NNN proceeds would be taxed at 28% to 39.6%.

  2. a 1031 can be done from a building to a vacant piece of ground, as long as it is investment property and not personal property.

  3. Bonus I knwo I said only 2 points, but the owner could do a 1031 exchnage for another residence, rent it out for a year or so then convert it to a personal residence or second home. For example a NYer could 1031 to a property on Miami’s South Beach, rent it for a year then use it as a retirment or seond home.

David Krulac

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Re: Two points, Frank… - Posted by Frank Chin

Posted by Frank Chin on January 29, 2002 at 20:54:12:

Hi Dave:

1- True, the lump sum proceeds from the NNN is due an ordinary tax, but not capital gains, because the lessor still retain’s fee ownership of the property. But keep in mind selling rental properties also triggers recapture, state capital gains, which would when added to the 20% federal capital gains, can reach tax rates of 40% as well.

2- I know of an elderly gentlemen in my neighborhood that owns several rentals, plus his own home, plus a place in Florida. He’s not doing much maintaining his properties, would like to unload them, but wouldn’t because of the capital gains. Doing a 1031 into other properties will not solve his problem because if he can’t maintain these properites, how is he going to maintain the ones he’s exchanging into.

If he’s going to 1031 into vacant land, then he’s better off NNN the properties he’s got, and collect the lease payments. Then he’s collecting something equivalent to ground rent anyway.

I think collecting the lump sum payment, even paying a 39.6% tax at least in the minds of these folks is that they still own the place, and they haven’t paid any capital gains yet. It’s halfway between having sold it (you got a lump sum), and still have it (you got the deed)

At least that was the logic when the Port Authority of NYNJ granted Silverstein Properties a 99 year leasehold on the World Trade Center. The Board was under a lot of pressure to sell the place to finance Mass Transit. Yet, they really didn’t want to sell it.

So they got several hundred million for the leasehold, was able to fund mass transit, and kept still kept title to the WTC. It’s a compromise between selling it and not selling it.

Frank Chin

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All good points, but… - Posted by David Krulac

Posted by David Krulac on January 29, 2002 at 21:27:43:

I keep seeing the 39.6%! The recapture is 25% and in Pa. the state gets 2.8%, so you end up paying either 25% or 22.8% versus 39.6%. but of course you would lose any future appreciation, which in a demand area is certainly not to be overlooked.

I was just telling somebody today that over the years I have sold a lot of property that if I owned today…

David Krulac