Local bar owner looking to sell, tax implications/capital gains amounts if owner lives in property (and has for 40 years)?

Question

Hi all, I listed a local bar/tavern recently and the owner lives in the upstairs and has for quite some town. When the property sells, what are the tax implications for the seller? There are no liens, mortgages, or encumbrances to pay off. She stands to clear $200,000+

The owner is also considering implementing a trust for a daughter and including this large piece of downtown property in it. I told the seller this would help protect from many types of taxes hen there is a sale possibly, but how can the seller pull out funds to live on after the sale or AT sale?

Thanks for any insight/input on this!

Bill Exeter · Answer

Hi Justin,

The portion of the property that has been used as the taxpayer's primary residence should qualify for the tax-free exclusion of up to $250,000 if single and $500,000 if married pursuant to Section 121 of the Internal Revenue Code.

I'm not sure about the rest of the property.  If it has been used for business purposes for at least a couple of years and up until very recently, then it would likely qualify for 1031 Exchange treatment.

The trust, unless she opts for some type of charitable trust, will not defer or exclude any of the taxable gain from the sale.  It is certainly a good estate planning tool that she should look into, but it will not help with the sale.

So, it sounds like she would qualify for the tax-free exclusion on the primary residence portion and the 1031 Exchange on the business use portion.  There are a number of moving parts here, including the computation/allocation of gain between the primary residence usage and business usage, so it is imperative that she meet with a good tax advisor that has experience in real estate.

The portion that is allocated to the primary residence does not have to be reinvested, so she can pull out cash through that part of the transaction.  She would not be able to pull any cash out of the business use portion if she is going to structure a 1031 Exchange.

Rick H. · Answer

I am NOT a tax guy, however an installment sale whereas the seller carries a note secured by the subject property would make taxable gains more manageable.

Buyer might need to pledge additional collateral ( I.e., residence) to make me comfortable. That's a typical SBA loan requirement.

Alternatively, seller could use a 1031 exchange accommodator and your assistance to find a replacement property that does cash flow along with some estate planning assistance from a qualified attorney.

Both strategies are simple. You'd be hero and should ask for a brag letter to put in your file (with the others).

Troy Fisher · Answer

Definitely look into both of these things more.  Simple answer - 1031 is a tax strategy (CPA), while trust is asset protection (Attorney).  They are two separate parts to any real estate investment.  You can easily 1031 property exchanges in a trust as easily as outside of the trust.

Troy Fisher · Answer

Again.  Here's the confusion Tax Liabilities and Tax Strategies need to be separated from Asset Protection Strategies.  It trips most people up because some people advocated really complicated strategies that use both.

Quite simply a trust can be seen a LLC.  It's an entity that is not the owner.  It separates the owner from whatever is held in the trust from any kind of (non-tax) liability.  Mostly things that would go to court, lawsuits and probate.  Another exercise would be the same as thinking of the trust as a whole different person.  I give you this property to hold for me.  While I am alive you keep a hold of it.  But I'm going to live here and you can do what you want with downstairs. However, when I die give it to my daughter!

The trust may or may not be a pass-thru entity mine are.  So any tax liabilities that the trust assumes pass along to me when it comes time to do my taxes, and it's just an extra form to fill out (for my CPA!).

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And as for collecting money, I'm trying to figure out if the seller can sell this once in a trust and collect money from that sale? I wasn't sure with how you worded your comment (or I may have worded the question/situation wrong) if you meant a check can be written to the trust, or out of without certain proof or documentation that the trust incurred an expense on behalf of the subject property? Thanks for the insight on how selling is just as easy when in a trust!

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The trust will have it's own checking account.  When the property is sold the money should go into the trust it protects the veil.  But just like any other checking account that is not a business account she can write checks, and use an atm card just like normal, but instead of her personal name it goes into the name of the trust.  And all the money and assets pass along without being subject to probate.  Estate Planning!  here's a link from AARP: http://www.aarp.org/money/estate-planning/info-09-2010/ten_things_you_should_know_about_living_trusts.html

I shan't make any guesses on tax liabilities.  It's not my specialty.  I'm happy to pay them when I have to, but I'd 1031x the property because I am in an acquisition mode.  She's in another boat and I don't have a suitable answer.  Meet some CPA's and Estate Planners, it will do wonders for your business.

Justin Polston · Answer

Troy, I want to elaborate on something now that I have some more time to read over what you guys had to say.

Seller might continue to live upstairs but has remarried recently, and may move in with significant other. If seller does continue to live in the upstairs, while placing property in a trust, will there be a rent liability to the seller at this point?

And as for collecting money, I'm trying to figure out if the seller can sell this once in a trust and collect money from that sale? I wasn't sure with how you worded your comment (or I may have worded the question/situation wrong) if you meant a check can be written to the trust, or out of without certain proof or documentation that the trust incurred an expense on behalf of the subject property? Thanks for the insight on how selling is just as easy when in a trust!

What would you suggest if you were in the seller's boat? I spoke with her this afternoon for a bit, and she's stated she doesn't want to rent out and let the trust collect money, she wants to cash out. But, she's unsure of her tax implications or capital gains taxes without being in a trust while maintaining it's her primary residence. @Bill Exeter

Is the previous paragraph something you have some insight on? Thanks all! I don't like asking for help but I really want to be able to give this seller everything I can as far as suggestions and insight.

Justin Polston · Answer

@Troy Fisher

@Bill Exeter

Thanks guys so much for the insight! I have to get to an appointment, but I will come back to this thread and continue the discussion because the owner will probably be pursuing some of these options if not both.

Troy Fisher · Answer

Continue Living there? - Yes I live in a property that is in a trust.  Most of my personal assets are in a trust.

Collect the Money? - Simple as pie.  The check is written to xxx, (type of) Trust and is deposited into the bank.

Are Trust more difficult?  Nope.  Trusts are simple to move property into.  A quick deed, silent deed, or any other deed transfer.  Should be tax free (maybe a filing fee from the county/state) into the trust.  And selling is just as simple.  Everything is signed by the trustee.  Just sold some of my property out of a trust.

Think of a trust as a big safe deposit box.  You put stuff in it, and no-one is able to see what's in it unless they have the keys (the Beneficiaries, the Trustee).  If you want to move something into and out of the box, you go to the bank (your trust administrator) and they let you do it!  Doesn't matter cash, property, cars, airplanes, mineral rights, stocks, coins, grandmothers antique shotgun, whatever.

Justin Polston · Answer

@Rick Harmon

Thanks for the specifics on your comment! I've never heard of a 1031 (and I'm trying to figure out why!).

I have been pushing the seller financing strategy, but the seller is well into the prime age of 80s. Not really an option, but leaving it to the daughter is something that would make the seller happy and I think that's where we'll end up is a sale within a trust.

Having, reluctantly, not heard of the 1031, is it fair to ask how this works (if it's not using the funds of a sale within a trust to purchase a similar property)? You said relatively simple, so your continued insight on this is appreciated. I'd always like to be the hero!

Do we think it might not even be the best scenario to place this into a trust?

Justin Polston · Answer

Absolutely. I did advise her to a local attorney/accountant in town to build off the ideas, but looking for opinions from fellow BPers.

And yes, there will 100% be a tax liability. There is no cashflowing to this property and it is used as her personal residence. It was an active bar until recently though. However, I'm just trying to figure out how the rates adjust once someone lives in a property for several years. This isn't something commonly occurring around here.

As far as the trust, looking to see if seller should place property in the trust (and continue living there?) but question is how to collect money for seller once the property sells, as the owner isn't necessarily the seller anymore once placed in a trust. Would the trust component make a more difficult sale (I think it might) and once a trust holds just cash, what must happen?

I am trying to figure out a way to make this NOT MESSY lol.

Again, just looking for others who may have had a similar situation and what they ended up doing. Thanks for the insight @Troy Fisher

Troy Fisher · Answer

First off, you can guide the seller, but they need to talk to a CPA or Fiduciary, estate lawyer. Someone who is certified in financial planning, and hopefully holds a state license of some type.

I'll assume there is still tax liability because it's not _JUST_ a personal residence and it has a commercial component.  Second off, some sort of TRUST structure is going to allow her to enjoy her monies and pass them along avoiding probate after death.

Local bar owner looking to sell, tax implications/capital gains amounts if owner lives in property (and has for 40 years)?

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