land trust to avoid capital gain?

Question

Is there a way for a seller and I to set up a land trust to hold the properties I want to purchase from him and he be able to avoid his capital gain tax?

Bill Exeter · Answer

Hi Brad,

Not necessarily.  Today you have various capital gain tax rates and you have the Medicare Surcharge (Obamacare tax).  The rates depend on your Adjusted Gross Income, so managing your AGI down can save you quite a bit of money.  You can avoid the 3.8% Medicare surcharge and reduce your capital gain rate from 20% to 15%.  The seller carry back note can be an incredible tax planning strategy.

David Krulac · Answer

Brad V.

The seller would defer some tax by financing the property, essentially paying the tax as he received the payments.

The seller could also do a IRC Section 1031 and defer the taxes to death and beyond.

Boyd McClean · Answer

I believe this is called tax fraud. If it was acceptable method everyone would be doing it.

David Krulac · Answer

Brad V.

is the expert on 1031s

Bill Exeter · Answer

Hi Brad,

1031 Exchange

If the Seller wants to remain in real estate, he/she could structure a 1031 Exchange transaction and reinvest in other rental/investment real estate.  There are also options that have less property management headaches involved such as Net Lease Properties, Tenant-In-Common Investment Properties (TICs) or Delaware Statutory Trust Investment Properties (DSTs).

Installment Sale Treatment (Seller Carry Back Financing)

The Seller would recognize depreciation recapture in the year of sale and defer some or all of the capital gain over the term of the seller carry back note.  It depends on the terms of the note.

Bill Exeter · Answer

No, it won't work.  Land Trusts are both "pass-thru" entities and "disregarded" entities, which means they are ignored for tax purposes.  The gain would be triggered with the assignment of the beneficial interest from the seller to you as the buyer since the assignment is considered a conveyance of title.  Using the Land Trust in such a manner would be considered tax evasion.

Bill Exeter · Answer

Hi @Nadine Lajoie,

The Title Holding Trust or Land Trust is certainly designed for confidential and private ownership of real estate.  It does not terminate at death; it does by-pass probate, it does pass ownership of the underlying property to the successor beneficiaries, etc.

However, it does not avoid any due on sale clause, income taxes, capital gain taxes, reassessment for property taxes, etc.  There actually is a change of ownership.  Legal title has not changed, but the actual ownership of the property has changed.  The trust is a pass-thru entity and a disregarded entity.

Many investors use it to avoid those items mentioned above, but that does not mean that it is legal - they just have not been caught.  It would likely be tax fraud, lender fraud, etc.

We are very careful when accepting new Title Holding Trust clients for these reasons.  THTs are very basic trusts and serve an important purpose of confidentiality and a few other benefits.  Unfortunately, there is a lot of abuse of THTs.

Nadine Lajoie · Answer

I thought that a land trust is transfering title from a property, helps identity protection, but in case of death the land trust is still surviving, which avoid the probate,Capital Gain taxes and Prop 13 8n California, because there is no Change of ownership. At least CG is differed until the property is actually sold in the future???  And because a land trust is like a separate entity, the capital gain will be paid inside the LT, right?  Not on a personal level, just the distribution to the beneficiaries.  Is this right???

Thanks

David Krulac · Answer

Brad V.

the first is "Installment Sales Treatment".

Dave Foster · Answer

The real power of the ability to defer payment of capital gains tax in a 1031 exchange lies in the compounding nature of your use of that deferred tax.  Once set upon a course of long term use of 1031s to mitigate your tax bills you will in essence receive an interest free loan from the government to reinvest in additional real estate.

Very similar to the power of the IRA but outside your retirement umbrella.

And then there's always the numerous ways to not just defer but eliminate the tax entirely.  So no, you don't always have to pay the same amount eventually.

Usually when sellers learn that they can use 1031s to adjust their tax liability.  And when their eyes are opened to the compounding power of the 1031, the options to eventually eliminate the tax, and passive investment options available,  they take a second look at their options to stay in a qualifying real estate position like those passive opportunities @Bill Exeter iterated above.

land trust to avoid capital gain?

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