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Some End-Of-The-Year Thoughts For Real Estate Investors

Jeff Brown
3 min read

Since a new year is literally 37 days away, there are some options you may wanna ponder. This is particularly true as it relates to income taxes. The end of a calendar year allows a little more room for planning how you might structure the sale of a real estate investment property. Like some years in the past, a couple in the 1980’s come to mind, potential tax changes in 2011 will/should factor into your decisions. Duh.

For those who’ve decided to pay capital gains taxes on a sale, and have the ability to close before January 1st, here’s something to consider.

Allow your buyer to split his down  payment between this year and next. If escrow closes on December 28th, the buyer can put half of it in cash this year, and the rest a week later, in 2011. This will give you more time to pay the taxes, yet still get you the money relatively quickly. The risk this year is whether or not Congress will extend Bush’s tax cuts. To many that will matter greatly, but to many it won’t mean much. If the gain is significant, you can decide to stretch it out three years, into 2012. You’ll receive your money in roughly 54 weeks. But your taxes will be spread over three tax years. Ask your tax expert if that approach makes sense for ya.

Here’s a nasty surprise of which the majority of long term real estate investors are unaware.

Let’s say you’ve decided to execute a tax deferred exchange on one or more of your properties. You sold it (them) and escrow either has closed or will close this year. You may be aware of the delayed exchange rules as they relate to time limitations. There are two that begin ticking from the day you close escrow on the property(s) to be ‘relinquished’.

The first is 45 days — which is how long you have to formally ‘ID’ the property(s) you’ll be acquiring. The second is 180 days — the time you have to close the identified acquisition(s).

If your stuff closes sometime from today through December 31st, your 45 day period commences counting down. However, and this is huge — You don’t have 180 days in which to close what you’re acquiring. Instead, you have till April 15th. The first time I ran into this, back when I was a pup, the panic was immediate, as it was late March, and my clients’ exchange had no chance whatsoever of closing before April 30th, if not later. They, (me included) thought their 180 days ran through around June 10th.

The rules say that if you close the front part of a tax deferred exchange in one calendar year, and close it in the next calendar year, the closing date must be on or before April 15th, when income tax returns are due.

Did I mention the panic attack?

Once breathing into the brown paper bag did its thing, and I could more or less focus, my CPA gave me the Get Outa Jail, Free card. Simply file for an extension on your income taxes, and your taxes are now due in October, not April. You’ll have successfully reclaimed the full 180 days you may need. Man, just writin’ about this made my heart speed up a bit. 🙂

Here’s a way to potentially increase future tax shelter while decreasing future capital gains taxes.

Whenever we take on a new client, especially when it appears a tax deferred exchange may be on their menu, we ask them if they have any unused deprecation. Typically they don’t know what I’m talkin’ about, so a quick call to their CPA is made. Recently we discovered one client had just over $100,000 in dust collecting depreciation. This allowed them to apply up to that amount to any capital gain as an offset. Though they ultimately ended up with the same properties they would have had they exchanged their entire equity using Section 1031 of the IRC — two of the smallest props were bought with the untaxed cash, made available via the unused depreciation.

Those two props weren’t, therefore, burdened with the clients’ adjusted basis from the relinquished props. This resulted in a significantly higher annual depreciation. Also, since there was no adjusted basis in the equation for those two props, their basis was higher than those acquired via the exchange. When it comes time to sell and/or exchange those two, any potential capital gain will be less than the props acquired through the exchange.

It’s not the answers to the questions you ask that usually bite ya in the butt. It’s the answers to the questions ya never knew to ask.

I wish everyone the best, most loving Thanksgiving ever. And remember — your job is to eat WAY too much, then have at least two different desserts.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.