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Assisting landowners impacted by public use projects using a 1033 Exchange

1033 Exchange

If you are a landowner, we would like to introduce you to a powerful, yet little-known tool: The 1033 Exchange. This tool can not only be used in this current tax year, but may allow you to go back up to four years and recapture tax money you’ve already paid the IRS.

Across the Midwest, the growth of infrastructure has been breathtaking. The long-term benefits of these new roads, pipelines and transmission lines will hopefully be worth the cost. However, it may be the local landowner who’s paying the biggest price in these projects today. He or she is usually helpless to prevent these projects from running right through their backyard; often across land that’s been in their family for generations.

Once the landowner has agreed to “just compensation” for the targeted property, he or she is often surprised to find the IRS knocking on the door asking for a share of these proceeds.

While enduring an oftentimes painstaking negotiation process, the landowner is left with two harsh realities:

  1. The taking of his or her private land.
  2. Forcing the landowner to pay capital gains tax on a sale he or she never asked for or wanted.

We’re here to help. While we can’t stop the project from taking your land, we can work with you to help prevent the additional loss in the form of unnecessary taxes. The 1033 Exchange can defer current taxes, and even recapture capital gains taxes paid on money received up to four years ago.

If you find yourself in this situation, you generally have a few options, which may include:

  1. Pay the capital gains tax and use the remaining cash as you wish.
  2. Do a 1033 Exchange by buying a “like-kind” replacement property of equal or greater value to your proceeds. No capital gain tax is paid, but there is no remaining cash either.
  3. Do a 1033 Exchange using a Delaware Statutory Trust ("DST") as your replacement property. No tax paid, and remaining cash dependent on amount of leverage utilized in the DST. (If you’ve already paid taxes on money received, you would invest in the DST, file an amended tax return and in 1-3 months, you’ll receive your money back from the IRS.)

In most cases, options 2 or 3 will be preferable to most people. If you do not have another piece of like-kind property to buy, or at a price you’re willing to pay, option 3 may be suitable for you.

The IRS has allowed DST’s advantages when used in a 1033 Exchange:

  1. DST’s satisfy the “like-kind” requirement;
  2. DST’s are allowed to use leverage resulting in landowners deferring the entire taxable gain by investing only a portion of their proceeds.
Example:

Example:

You have a $1M gain on a forced sale or easement, you invest $500K into a 50% “loan- to-value” DST. The DST uses financing to purchase an additional $500K of real estate in your name. Between the $500K you invested and the $500K of financing, you now own $1M of replacement property. This defers the entire $1M of capital gains. You have now deferred every penny of tax: $500K of cash in your pocket and a $500K real estate investment that seeks to pay out a 5-7% annual cash flow.*  For more details, please see the Frequently Asked Questions above.

Stop in for a cup of coffee, or give us a call, and we will be happy to visit with you about your situation to determine if a 1033 Exchange would be a good fit for you. 

*Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.

The information herein, including hypothetical examples, has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation.

DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65. Individuals holding a Series 66 do not fall under this definition) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.