170: How to Deal with Capital Gains Taxes!
Buck: Welcome back to the show everyone today my guest and well formula podcast is Brett Swarts. He is the CEO of Capital Gains Tax Solutions. Capital Gains Tax Solutions helps investors and business owners maximize what they keep in their pocket after some kind of a liquidity event and Brett has expertise in a number of different types of strategies including deferred sales trusts which we’ll talk about Delaware Statuary trusts and 1031 exchanges he is also a real estate investor himself so he’s not coming at this completely as a theoretical thing and he also happens to be a commercial real estate broker. Brett welcome to the show.
Brett: Thanks Buck for having me.
Buck: So wanted to talk to you first just you know get a little bit of background find out you know who you are what you doing how’d you how’d you get into the you know ultimately in this business of dough where you alright not deferred trusts.
Brett: Yeah the deferred sales trust right oftentimes this confuses the Delaware because they both have the DST acronym. Started back originally in the Bay Area San Jose building homes my dad learning about a real estate and investments and rentals and I went on to college and I studied business at the time I took an internship at a company called Marcus where we helped people buy and sell apartment buildings and at the time we just did 1031 exchanges and which were great vehicle to defer taxes on white pine real estate and a great way to build wealth however along the journey especially here in California where I’m from there comes times when the marketplace doesn’t make as much sense to do a 1031 when the prices are very high for clients we’re looking for an alternative as a part of that my manager brought in a gentleman who spoke about the deferred sales trust and that started the journey down this alternative to a 1031 exchange I received my series 22 and 63 licenses and started to help clients that use this structure about 10 years ago and fast forward to where we are today it’s sort of the perfect storm of what’s happening with the marketplace but it’s hard to find value-add deals that make sense and also people are selling businesses and primary homes which don’t qualify for a 1031 exchange so these become a great option for those to defer tax.
Buck: So let’s talk about the problem in general first I mean basically you help people with capital gains mitigate tax liability. You mentioned business owners so do you focus on real estate investors or business owners or both or what is your focus in particular?
Brett: My focus is on the business professional the trusted advisor the business broker the commercial real estate broker the financial advisor and the luxury real estate agent are the top ones and our goal is to equip them with the tool so that they can go out and add value to their clients and help them when they go to sell and also grow their business but oftentimes we’ll have the client call us directly we say look bringing your trusted advisor what’s all work together to make sure as a team you’re comfortable to structure the strategy and how this all works. The big problem that people are faced is is what’s called the I guess the 17 trillion dollars is passing from one generation to the next in the next 20 years and this is known as the baby boomers this is the largest wealth transfer in the history of the world that we know of and in fact there’s about 77 million turning 60 or in the US alone about 10,000 every day turns 65 and they’re faced with how to sell and get out and get out of debt and diversify and become liquid without getting hammered by 30 to 50% of their gain and so we use this deferred sales trust to give them this solution to give tax deferral liquidity and diversification and they really feel trapped that’s the best part of what we do is we get people from from away from the feeling of being trapped in their asset or in their business and having to have employees and liability and the ever-changing regulations that especially here in California or just managing toilets and trash and so we get them out of all of that and get them on the sidelines per se and completely passive in their own portfolio of liquid investments.
Buck: So let’s talk a little bit about the different options out there let’s start out with the 1031 exchange that’s the one that most people who are familiar with real estate have at least heard of and they kind of understand it in theory but would like you to just kind of go over it a little bit and kind of review it for us if you would.
Brett: Absolutely 1031 exchanges a great tax deferral strategies one of the most well known but it’s very particular it’s a for really investment property like kind real estate these recent tax laws become even more restrictive to basically like kind investment real estate and it’s where you know Buck if you were to buy a property for a million dollars and you you made a profit of you know up to let’s say three million instead of paying the tax you can do what’s called a light kind exchange and you can move those funds into another property within a short period of time 45 days to identify typically in a hundred and eighty days to to close on those properties most people choose the three property rule but the intent is just to keep the taxes deferred and earn more wealth on the next property so I help people do 1031 exchanges it’s a great tool some of the shortcomings have to do with the fact that it is a short time period and if you can’t find a property that makes sense you know within that short period of time and you don’t follow the rules the exchange fails so a lot of our clients feel rushed trapped forced to make quick decisions before they meet us on the other side of the deferred sales trust there’s no timing restrictions you can buy real estate whenever you want to because it’s a different tax code it’s an installment sale versus a 1031 exchange. The second thing with the 1031 exchange has to do with the depreciation schedule that actually travels one of the best reasons book to own real estate is the depreciation the offsets the income that’s coming in right so however if you want real estate for long enough and do multiple 1031 exchanges eventually your depreciation can go to zero and that’s where a lot of our clients are facing their long-term commercial real estate owners and so if they were in a trade that schedule travels which is not good. The other side of it is the deferred sales trust the funds can be directed to a trust and then directed to a commercial real estate deal and then they can get a brand-new depreciation schedule and the last one has to do with just buying in a high market place. Parents taught us to sell high or buy low and sell high and then buy low again well the 1031 because it’s the 180 days you’re typically selling high and buying higher again due to the low inventory and sometimes with rising interest rates you end up really in a tough spot.
Buck: In terms of I think there’s one other part that I think it is interesting is that there’s a requirement to have the same amount of debt is that right when you when you transfer it like do a 1031 exchange?
Brett: A hundred percent right so the debt replacement so you need to buy something equal or greater value which often means you’re actually taking on more debt because the property values are higher and that’s what happened in the 08 crash a lot of my clients got hit and 05 06 07 Trading up they couldn’t refuse that offer and they just rolled it in the 1031 because they felt they had no other option I didn’t learn about the strategy to about 2009 on the deferred sales trust and then when the market shifted they were hit.And the concept here I like to have my clients think about is the the idea of dumb debt or risky debt and smart debt. Smart debt I think takes on debt when the market place is low when it’s a buyers market you can find a value add play force depreciation and make sense of a deal welcome Californians about five years ago you know those were most of those deals maybe three years ago but it’s kind of dried up this last couple of years every markets a little different. Risky debt stays in the property after they’ve added value and if the market shifts you’re risking some of that equity that she’d gained over the last couple of years and I would say dumb debt is sort of what happened in the 05 06 where people double down and buy bigger and bigger properties and take on more and more leverage even if they can’t find a value add play there just to defer the tax and then they end up getting hit at the market shift so I think you always got to consider how you’re gonna diversify and pay off that debt. The deferred sales trust by the way is we call it the Dave Ramsey debt free plan for your business or commercial real estate because that close of escrow only the proceeds go into the trust therefore your debt free on that particular asset which is taking risk off the table for you.
Buck: I want to I want to go into the the deferred chillz trust in detail in a second but before that let’s just cover the other thing that you mentioned which you know there’s some confusion on is you there’s some there’s a fair amount of nomenclature in the space and I had a show a couple months ago on the Delaware statutory trust and that’s basically a 1031 exchange as well I mean it’s you know the differences it’s a it’s something that people can take their gains and and then you know transfer into it sort of like a syndication the downside there being that there really is not a whole lot of value-add allowed in those kinds of things. So the returns are gonna be modest and you’re basically going from one and then you’re ultimately you know when that fund ends you’ll need to look for another fund or buy another building is there anything else to add on that front?
Brett: Yes so non liquidity right so typically you’re moving into a mutual fund of properties one two three properties have done Delawares with clients in the past they can’t really serve their purpose with mortgage over basis issues if any of your clients have a mortgage over basis there are some high LTV companies that you work with to distinguish that debt as a form of a partial 1031 and a partial deferred sales trust. But the non liquidity is a big one for a lot of our clients right now a lot of our clients want to be out of debt and they want to have the ability to access the cash now they’ll pay the tax that they dip into the principal for our trust and or direct it to multiple commercial real estate syndications not just one two or three Delaware’s. So for example if you had a client is selling a five million dollar business or property or primary home they can direct up to 80 percent of the funds into multiple commercial real estate syndications in multiple geographical locations and the entity itself doesn’t have to move into it can move into all of them it’s not a 1031 so we don’t follow those rules so it gives you more flexibility where is the Delaware you’re basically going to be tied up for typically seven to ten years non-liquid and you’re completely passive meaning you’re giving up all the control to the manager and you’re right typically there are very nice properties maybe some value add but the returns are modest and the fees are pretty high.
Buck: So let’s talk finally about the deferred sales trust now first of all I need to clear up but again nomenclature in this space is tricky there’s a I’ve heard of something also that’s called a defer installment sale is that the same thing as a different sales trust or is that a different animal?
Brett: Not that we know of . Maybe it’s not monetizing top install bring you use the IRC 53 which the tax code you know what I would encourage your listeners to do whenever they hear this new strategy from this guy named Brett on the deferred sales trust or the monetize or any of these strategies the number of questions you should ask is personal with the tax code how do I know it’s legal how many IRS audits and how many of these have actually been done and what have been the results of those audits. So our track record is a 23 year track record over so close to 3,000 trusts that have been closed no change IRS odds but that being said we’re not the monetized I don’t think they’ve been around as long I don’t know their history of the IRS for the level of completeness.
Buc: Can you talk about that in theory and then we’ll get into you know cuz I’m what I’m trying to do here is kind of provide all these different you know terms I think there’s a lot of confusion out there but when you hear about a monetizing installment sale what why don’t tell me what that is and then we’ll go directly into that.
Brett: Yes so it’s a form of the installment sound again I haven’t done one of these so I can only speak from what I’ve read online and then they can be in the general people I’ve talked with who are considering both sides us or them what I do understand is it’s a 30-year term we’re compared to ours which can go on as long as you want they can pass on to your kids you can go every 10 years you can go for 10 10 10 10 and keep passing on to your kids and they can keep going or if there is just 30 years their concept is giving ninety three and a half percent of the money upfront meaning you’re taking actual receipt of the funds whereas ours a hundred percent of the funds or whatever funds you want to be deferred will go into the trust to maintain non actual receipt so those are some of the technical things but they’re both a form of installment sale to both a form of tax deferral but we’re just very cautious on their strategy for a number of reasons and they’re our competitor but we want to be careful what we say about about what they do.
Buck: No I get it and I think I’m just trying to again just for completeness make sure that we cover all of the terminology. Let’s talk about let’s let’s define then the deferred installment sale as you do it then let’s go back and since and then sort of compare and contrast with all the strategies if you would.
Brett: It sounds great yes the deferred sales trust it’s just a manufactured installment sale it’s based upon IRSC 453 what you just sell a carry back law which you know Buck and a lot of your clients probably do too and if they don’t their CPA definitely does and so how it works is let’s say Buck you were selling a property for 10 million and I wanted to buy it personally and I came to you Buck look he owned this property free and clear you don’t necessarily want to do a 1031 exchange how about I give you a two million dollar downpayment and you carry a note for eight million and that scenario Buck how much actual receipt did you receive right so two million good million right so there you go tax on that but if I came to on another scenario and I said how about I give you a zero down payment would you carry a note for ten now hypothetically if you did that how much actual receipt does you receive nothing nothing you got it so picture the trust so we’re gonna do Buck because we’re gonna have a cash buyer lined up they can’t get a loan you’re getting ready to sell your apartment complex for 10 million it’s all ready to go what’s gonna happen is the deferred sales trust you’re gonna see a brand new entity it’s a Missouri business trust it only does business with you Buck you can call it bucks to firm sales trust it’s gonna jump in right before close of escrow and it’s gonna buy your position for 10 million.
Buck: Where does that money come from?
Brett: Buyer’s it’s already there yes the buyer the buyer is about to buy it right well we’re gonna jump in right between right before and we’re gonna give you a note for 10 million the trust is you know it’s gonna say we promise to pay you Buck 10 million dollars we’re gonna do a zero down payment in exchange for this promissory note.
Buck: So I have no gain at this point.
Brett: Well tax is due just haven’t taken actual receipt of the principal balance which is the trigger under IRC 453 for the tax being due in that given day or that year okay now immediately when you sell it to us for 10 million in exchange for that note we’re turning around for that cash buyer who’s already lined up and they’re actually gonna buy it from the trust okay okay so the 10 mil is gonna go into the trust. Now Buck if the trust bought for 10 million and sold for 10 million how much tax is the trust?
Brett: Right cuz it bought and sold for the same price now then our takes title the same way he would have he’s gone he’s cleared he’s got the property and the smoke settles and you have a note for 10 million and the funds are sitting where Bank of New York Mellon Charles Schwab TD Ameritrade you can hire your own financial adviser by the way we have over over we have thousands of professionals across the US CPAs tax attorneys financial advisers who are all in the individual space and they help their clients with their strategy but you can hire your own by the way the funds only remove with your signature and they can be directed like a set IRA in a sense where you can kind of say I like to have it in some of some commercial real estate some stocks and bonds some mutual funds but the key thing here is you haven’t touched any of the principle and you’re living off interest payments most of our nodes earn 8 percent and after fees they met you about six and a half percent.
Buck: So let’s jump into some more detail there because that’s where and now we’ve got so now I come back on this a little bit first let’s let’s work with what we have so now we’ve got ten million dollars sitting there your are you this is effectively at this point you know like you set whatever you want to call it it has to be managed by you know some sort of trust D and at this point we’re focusing our money in traditional investments like equities and bonds?
Brett: Correct you can yes so my role is I’m actually the trustee that’s actually my role so I educate everyone I’m strategy but how we actually get paid our company is for the trustee so the trustee must be a third party unrelated trustee so can’t be your brother your sister your cousin and they have to be in it for business purpose these are some of the IRS guidelines to make sure the integrity maintains yeah so the 10-million is there and we’re kind of acting is like a custodian if you know although our funds urban funds are always at the bank and always at the end with the investment advisor.
Buck: Do you have to use I mean I guess one of the questions I have is can you self direct this like in other words you know a number of our investors number of people in my group they like to you know that was self directed 401k QRP whatever you want to call out or self directed IRA and they’re investing in real estate of their choosing is that is that an option at that point or is that money sort of more in traditional you know real estate adviser territory at that point well let’s or not real estate but just you know a registered investment advisor.
Brett: An IRA or financial adviser so it all depends okay so the the big answer is no you can’t self-directed meaning you’re doing like an e trade account or you’re doing some kind of form of day trading right it can’t be that that’s that’s too much control it must be a third party unrelated trustee that maintains non constructive receipt. It’s kind of the same reason you can’t 1031 into a primary home because you’re really you really need taking constructive it’s no longer in an investment purpose so we got to maintain this thing now however you can form an LLC Buck tomorrow and you closed the trust or day one eighty one or five years from now and you can have the funds up to 80 percent can be into this trust of which you’re the managing member of and you’re gonna partner with your trust all tax deferred to go buy your own property or put it into a syndication deal in that sense you kind of got control again right although you’re just partnering with the trust it’s typically a 90/10 split with the trust okay even though the trust puts about 100 percent of the funds Buck you have the sweat equity and you you’re the brains of the of the LLC so you can do that so in that sense that’s my favorite part because as a commercial real estate investor for where my clients come from we’ve made our wealth in commercial real estate not so much in the stock market although you know I have an 80/20 type of you know balance for myself but everyone’s different some people may want to put a hundred percent with a financial advisor and that’s perfect for them that’s great you know some people want to put fifty percent in commercial real estate but just not today maybe tomorrow the funds can also be directed to a lender who can do who can do hard money lending things to be directed to a business to open up a new business they can also be directed to do a development however all that being said there’s a risk tolerance that’s at the very beginning from funds going anywhere but you’re gonna fill out and based upon that risk tolerance will determine how where the funds are invested. So my role is the trustee is to ensure we’re paying you back that promissory note and our 23 year track record all our advisors across the US we have we’ve been able to do that and typically it’s about an 8% return over 10 years. So we’re all working together as a team.
Buck: Where’s that 8% coming from?
Brett: Yeah based upon the investments over a 10-year period.
Buck: So that again we’re talking about the you know like again and then at six and a half percent cuz you’ve taken a one it’s basically one point five percent management for you right?
Brett: So the cash flow is is six and a half percent over the life but at the end of the term going to net eight percent okay going to net eight percent that’s what our advisors have been able to now this is not this is not…
Buck: But that’s historical data once again and it’s using the equity markets you know sort of like your typical investment advisor would do right I mean there’s not like again I’m just putting this in the context that most you know most of my listeners are not stock people right there they’re real estate people and so when we hear you know investment advisors saying 8% or six and a half after whatever they say okay well how’d you get that number just by hoping right and so or historical data and I don’t I’m not trying to be a jerk I’m just saying how do you get the…
Brett: the answer is where do you get the fnds. The credits for in this position you have the options for how the funds are invested and so we get that the past performance is not we can’t predict the future results based upon that we some years maybe twelve some years maybe four some years maybe fifteen so negative for the markets gonna be the market but the goal is to just defer and live off the interest and by the way at the end of ten years you for a new for another ten years and keep this thing going we define losing as paying the capital gains tax and yeah for all living off the interest.
Buck: So at the end of 10 years say you wanted to go back into a real estate project could you do that could you then complete that sort of you know say it was a 1031 that you wanted to do or whatever the case may be or would you pretty much at that point if you’re not going to renew this thing you’re gonna pay capital gains.
Brett: So it’s not frozen you can’t freeze a 1031 and then thaw it back out that would be the best of both worlds we can’t do that.
Buck: I get it I get it so so if you’re so theoretically I guess what I’m trying to get at is if I’m a real estate investor if that’s really what I like to do. I’m saying okay well about 80% of those funds I can borrow and I can direct into you know as a limited partner in syndications which again is a big part of my group is you know investing in syndications as a credit investors and they can do that. And then would they is and then obviously there must be some kind of nominal interest you’d have to pay back right I mean is it just market rate maybe you’d be paying yourself anyway right so it wouldn’t really matter right?
Brett: You’re catching on Buck yeah so you’re actually not borrowing from your trust you’re actually partnering with your trust but we have to call it the go fund yourself you know how there’s girlfriend and you get other fund you well using your own trust yeah partner with your trust which is going to fund a fund up to 100% of the down payment at which it’s a 90/10 split which this is the next part for your listeners they’re really gonna like it achieves the brand-new depreciation schedule. Of which you can do accelerated depreciation you can add value you sell for let’s say a two million dollar profit what happens well the original money goes back into the trust plus the preferred return which we typically mirror the note and then 10% of the upside but the other 90% goes to you Buck of which you can do a 1031 exchange with or you can roll it into the trust as well and do it all over again. And it is optimal timing okay this is the biggest thing that it’s just I want your listeners to understand is you can get out of debt when the market place is really high and people are overpaying and interest rates are very low and inventory is very low and you can wait on the sidelines you know and buy whenever you want and diversifying to as many deals as you want as long as it’s with eighty percent of the funds and that that gives you a lot of takes a lot of risk off the table and also gives you a lot I think we think a compelling advantage to create preserve more wealth and go with the means.
Buck: What happens with the gains that are happening inside the trust how are those taxed?
Brett: Yeah good question so depending on where it’s at and that would be the brain surgeon CPA question on those particular details and your circumstance so my I like to say is my role is just a nurse so I’ll take the pulse before you get surgery make sure you talk with the brain surgeon hey bring your other brain surgeons in so your CPAs tax attorneys and on that level you’re going to want to those are really detailed stuff that our CPAs can definitely answer now and I say are they’re not mine our company is separate from the law firm the law firm is Campbell law firm and we’re just one of the exclusive trustees for the estate planning team it’s just a big membership organization but yes we can give consultation for all of that and we don’t charge it for that by the way we only charge if and when the client closes the deal but that would be broken down and and provide it for with each particular case.
Buck: So this obviously is is you know and we can talk about fees and that sort of thing a little bit in a minute but one other there’s two other things scenarios I want to talk about and one is frequently we see we you know when we have property we may have something and you see this all the time you bought something for two million dollars but you only you know you had a half million dollars in this thing and depreciate it up five ten years later and you pull off a few million dollars but you’ve got some debt to pay off. In that scenario how would this work because now you’ve got debt to pay off which is again most real estate at least the way you know I’ve done it and I know there’s probably REITs and stuff out there that are buying multi you know multimillion-dollar properties cash but if you have debt on a property how does that change the you know the flow of things here?
Brett: Great question I think what your furniture buck is a mortgage over basis so someone who buys a property of five hundred thousand they add a bunch of value they refinance and cash out additional cash above and beyond their basis therefore that’s called a mortgage over basis issue right we can’t solve that the deferred sales trust alone in fact that would be taxed at ordinary income however this is where we enter a buy free call to buy a fraction or 1031 we’re gonna do a partial 1031 exchange via a delaware statutory trust and the remainder is going to go into a deferred sales trust so let’s walk through that. We have groups very large institutions who have properties delaware deals with about eighty four percent leverage okay. So you can put in a smaller amount to distinguish a big big debt and so we’re doing teal actually right now out of Georgia the gentleman is selling a seven million dollar apartment complex and he’s gonna do with basically a third a third a third. A third of its gonna go to the delaware to distinguish this mortgage over debt a third of its going to go to a 1031 which he found a nice deal and the remainder is gonna go to the deferred sales trust and so we like to call ourselves capital gains tax solutions although we focused like a laser on the deferred sales trust we’re gonna provide the pros and cons of each each scenario and then we’re gonna give a solution for that so we solve that with a delaware high LTV for a portion of it and the remainder goes into the deferred sales trust.
Buck: Okay I’m I’m a little confused on that so I better a better tighten it’s not because of anything you’re saying but I think it’s a kind of somewhat of a complicated situation so let’s talk about this again I’m gonna break it down say I’m gonna put this into a real real you know this is like somebody whose wants to do the thinking about this right so say I’ve got save got a property and I’ve just go he’s a two million dollar property I’ve got a million dollars of debt on it and I sold it for four million okay so now four million so I’ve got a million dollars of debt on it that needs to get paid before I could do anything else so now I’m down to three million. Because that went straight to the that 1 million went straight to the bank to pay off the debt do I have any tax do anything I don’t have any tax to pay there?
Brett: Is above your mortgage so no issue there okay we just pay off the debt and a three million would go into the trust and now your debt free from that property and you’re invested in whatever you want to invest in.
Buck: Okay so the three million that I have can you explain to me like the concept of splitting that up between the delaware statutory trust and the deferred tax sale then what what would you put where and why?
Brett: Okay so mortgage over basis issue I probably wouldn’t recommend a Delaware right now because the price.
Buck: Well but most people do right I mean that’s that the reality is most people are not at least in my group don’t aren’t selling properties that they hold that they keep you know free and clear they’re selling things that they have leverage appreciation on.
Brett: Correct okay so the answer is is totally flexible okay you could learn eighty percent into a deferred sales trust and twenty ten percent to a Delaware 10 percent to attend exchange and no how would you make that decision like okay so first thing we say what are your goals right were you?
Buck: I don’t want to pay tax that’s my goals.
Brett: So definitely use one two or three okay. So when do we use a 1031 I if I’m in your shoes I use a 1031 when I can find a value add force appreciation opportunity particularly multifamily senior housing a mobile home park so those are my favorite okay I have some retail and mixed-use but mainly those three okay be your better properties that are in you know good demographics decent B location so if you can find
Buck: I get it. I’m talking about the numbers here. The rest I can figure out. The rest I get the hardest name okay I’m talking about the numbers here though the rest I can figure out and press they get but what I’m just saying is from like you mentioned that once you have debt on there you can’t just do the deferred sales trust it anymore and I’m trying to understand that part.
Brett: Okay so debt over the basis okay so so let’s imagine your basis was zero okay you completely depreciate this for thirty years you have that one million dollar mortgage okay but that scenario we’d replace that 1 million so I would recommend buck we do a Delaware statutory trust to replace that 1 million so 84% LTV so what’s it gonna take to get that so that’s about let’s say 1 million five point eight for what about two hundred and sixty thousand dollars so I would say Buck out of your equity event of that of the four mil of the three million two hundred and sixty is going to go to the Delaware.
Buck: And that’s so we can leverage the leverage used by the Delaware statutory trust to get us back to basis.
Brett: You got that’s gone got it is gone of that equity to that Delaware which leaves us with a two point seven four of which we could say go for your 1031 goes shopping go for it wish you luck if it works out great.
Buck: Or do the Dell the deferred sales trust.
Brett: Correct or deferred sales trust right okay maybe we can save a failed 1031 exchange so we want to empower you with the trust you have the tool go shop and go negotiate they’ll find that deal for some reason it doesn’t work out or you have some extra boot that’s when we can jump in
Buck: No that makes a lot of sense I mean I’m just trying to you know I was just trying to understand kind of what you know in practicality how this all plays out because you know I think again most of my listeners who’ve got a property they’ve got appreciated property that has debt on it right and so I want to make sure we cover the nuances of that kind of thing. Now one other question is can you think of any way we’ve talked about businesses we’ve talked about we’ve talked about real estate where you have debt or maybe you don’t have debt. Is there any options for people who have got who are limited partners in real estate that you know about? This is a challenge that a lot of my folks have because as you may or may not know I I am in the business of real estate syndication and yeah we’ll have investors who come out with a big pop you know they buy to put in a hundred oh come out with a couple hundred or whatever or you know five hundred and they come out with a million whatever the case may be and that is one of those pain points that it seems like for the most part you know in syndications it’s very very difficult to do a 1031 exchange with limited partners and so I often get this question is there anything else we can do and perhaps you can answer that.
Brett: The answer is absolutely so most commercial real estate syndicators they struggled with capital gains tax when they go to exit their property they struggle with the carried interest they have of themselves plus the equity they put in plus all of the other limited partners who put some money into and so most just aside just to everyone pay their tax and come to me for the next deal and they go do it again and and that’s that works especially if the numbers are going well but there’s a better way it’s the deferred sales trust so let’s imagine there’s ten of us and we all bought an apartment complex right each each of us can have our own deferred sales trust buck so the 1031 exchange the challenge is the intent is hey if the entity could move would get everyone to agree and it all works out with perfect timing then great but if some people don’t want to do it then it’s a challenge and they say they want their cash or whatever right so most people say no yeah sales trust solves that and that one two or three or all ten can do their own separate deferred sales trusts half and can pay the cap take it take the cash and pay the tax the other portion can do their own deferred sales trust and then the beauty is the very next day and hopefully you save each person about 40% the very next day they can direct it to your next deal. So it gives you the ability to not have to raise as much but it also increases their overall return so we like to see me eliminate the need for the 1031 exchange.
Buck: And again that would be through the mechanism of the lane being that eighty per to that eighty percent correct.
Brett: The other 20% with the financial advisor hopefully earning somewhere around eight netting about six and a half so they’re still getting the cash full off that that’s just a reserved for that twenty percent to make sure we can service the note but right pay the tax and it’s gone forever defer the tax and earn interest on it’s the same reason you do a 1031 is the same reason you do a deferred sales trust.
Buck: Okay got it. So let’s talk about dollars and cents here. If I am an investor because we talked about that theoretical thing where now we’ve got you know we have the ability to use it deferred sales trust to help limited partners but presumably there’s a there’s a minimum you know if you have capital gains of obviously you know if you had a capital gains of like twenty thousand bucks you’re not gonna do something like this at one point you you say okay this starts making sense and what point is that?
Brett: What’s the ROI on our fees that’s a great question. So the typical minimums are five hundred thousand dollars of proceeds every hundred thousand dollars an actual tax liability deferred okay so five hundred thousand dollars of proceeds into the trust after you pay of all the debt closing cost for every $100,000 deferred so if it was a ten million dollar deal Buck and you’re only deferring a hundred thousand we’re gonna say just pay the hundred thousand walk away with nine point nine and just sit on the sidelines the wait for a deal right.
Buck: You want a five to one improvement.
Brett: That’s about the ratio that’s about the ratio you just give or take you know we’ve done some some smaller but our average deals about 2.6 million and we’re helping somewhere between you know 350 and five fifteen detached tax deferral right so it just it all depends it all depends. But if it’s a primary home or it’s a business right they really have no elegant solution for tax deferral beyond the 121 exclusion for the primary home and then we say you know and the numbers may change a little bit or a really really tight fixed income and may switch for the exchange buyer commercial real estate owner those are typically the numbers.
Buck: Got it well I put you through the ringer and you’ve either done a great job of dealing with my persisting questions.
Brett: Great questions Buck. May I share another big one for your listeners?
Buck: What’s that?
Brett: This is has to do with the estate tax okay Buck so anyone who’s 11 million dollars net worth and single anything above that they’re gonna be hit with the debt tax it’s called the estate tax okay the 1031 only solves stepped-up basis and an only solid tax deferral but it doesn’t solve the debt tax which is separate now if you’re married is 22 million so let’s imagine Buck one of your listeners Worth’s fifty two million dollars of which 22 million is exempt back thirty million dollars if it passes them to me a state and is still inside the estate it’s gonna be hit with 40% tax. A deferred sales trust can solve that we can sell move the funds into the deferred sales trust and then simultaneously move it outside of the taxable estate. Very powerful way to help save your heirs 40 percent.
Buck: Yeah and we call that tax the dumb tax by the way.
Brett: That might be the dumbest tax.
Buck: The dumb tax, the estate tax, because if you’re not smart enough to do some asset protection before or some estate planning beforehand and you’re worth that much money then.
Brett: Most are doing the estate planning but they’re doing small amounts and they’re exhausting their exemptions right you can take literally a thirty million dollar apartment complex and in one transaction we’ve been all outside of the taxable estate so we can do it no one else can do it like we do it when it’s all one big swoop as well as the tax deferral as well the capital gains tax deferral as well as the ability to get to get liquid and live off the interest right so those are that’s kind of our unique our unique pitch there.
Buck: So the one last question that everybody will say why didn’t you ask if I don’t is how much does it cost for something like this?
Brett: No no we try to keep our fees as low as we can but you know your average trustee if you hire a trustee to do something they’re one and one and a half percent our company we charge about a half of 1% about 50 basis points if you just stay with a financial adviser. If you go back into real estate commercial real estate of that eighty percent you’d be charged about 1 % now it’s an annual recurring fee okay remember the trustee must be in it for business purposes be able to make a profit so that’s part of that the other fees a financial advisor that’s recurring and they’re gonna charge somewhere between 50 basis points on the point so that’s kind of how I got to that six and a half percent I said you earn eight and hopefully net six and a half right. The last fee is the one-time fee to the tax attorney and that’s one point five percent on the first million and one point two five on the second or anything above that. So let’s imagine a three million dollar deal it’d be fifteen thousand on the first million and then it’d be one point two five percent on the next two million left order that includes onic defense and it also includes for the life of the trust the legal and tax structure of the of the trust. And as a reminder over three thousands of these have been closed we’ve already blazed the trail we survived fourteen no change IRS audits one of the biggest deals is over 125 million that was audited as well that they’ve had formal formal audits of law firm and the structure so we’ve blazed the trail but that’s the one thing I want to give you guys your listeners as much confidence as I can give it regards to we’re not asking someone to try something new it’s new in the sense that it’s they haven’t heard of it but the IRS tax code goes back to the 1920s so this is over a 90 year old tax law just most people don’t think about an installment sale in this way they really only ever think about the 1031 so we want to bring both strategies see what works best for you empower you with the strategies so again you can create and preserve more wealth.
Buck: How do we in touch?
Brett: Yes so BiggerPockets YouTube LinkedIn any of those just search Capital Gains Tax Solutions and then capitalgainstaxsolutions.com is the website. Add me as a friend or like our page and I try to just put out educational content and then search deferred sales trust I’ve been on a number of podcasts too.
Buck: Fantastic man well I appreciate your giving us all this information and hopefully you’ll have you back sometime.
Brett: My pleasure Buck. Thanks so much for having me.
Buck: We’ll be right back.