Do Not Transact a 1031 Until You Know About the Dynamic Duo

This article was written by David Fisher, Tax Strategist at Creative Real Estate Strategies

The Dynamic Duo

The Dynamic Duo can provide greater real estate wealth than a 1031. No, not Batman and Robin. No, not R2D2 and C3PO. And no, not the most popular dynamic duo from the old western movies, Cattle Drives and Beans.

The real Dynamic Duo is cost segregation and the Deferred Sales Trust.

Benefits of Cost Segregation

Cost segregation is a huge opportunity for real estate owners. When working with a qualified cost segregation expert, you can accelerate depreciation on your property and take advantage of bonus depreciation which in turn, can reduce taxable income and tax liabilities. Cost segregation may increase cash flow and help you realize higher returns on your investment.

Who knew that Congress would give property owners the opportunity to accelerate depreciation?

Depreciation Recapture in a 1031 Exchange vs. a Deferred Sales Trust

Depreciation recapture comes back into the sale when the property sells. The tax on the depreciation recapture will be about 25%.

Let’s say that the seller’s tax rate is 30% so he can arbitrage the tax rate by paying 5% less in tax. However, when you add in the cost of the cost segregation study, the tax savings may be negligible.

House for sale Shutterstock_1550930354Or let’s say the seller wants to sell his property and transact a 1031 exchange. The seller will be able to defer the cost segregation on the property they are selling, but a new problem is created on the replacement property.

In a 1031 exchange you can defer the depreciation recapture, i.e., cost segregation on the property that is being sold, but you do not get a new depreciation schedule on the replacement property. You may get a partial depreciation schedule, but not a new one so there is a huge potential benefit to the owner that he can’t take advantage of. A 1031 exchange reduces the depreciation benefit on the replacement property.

However, when selling and using the Deferred Sales Trust instead of a 1031, you do get a new depreciation schedule and the opportunity to use cost segregation on the new property. So, every time you sell and buy another property using the Deferred Sales Trust, you have the potential to create more real estate wealth than using a 1031 exchange.

When you use a Deferred Sales Trust to sell your property and retire, you can defer the capital gains tax, state tax, the Medicare tax, AND the depreciation recapture so you can still benefit from the cost segregation study by generating a larger pretax lifetime retirement income than if you paid taxes first.

The Deferred Sales Trust Solution

Now, be honest. The Dynamic Duo is a better opportunity than Batman and Robin and especially Cattle Drives and Beans. I will begrudgingly admit however, that the Batmobile was cool. If this sounds like a solution you’d like to explore, let’s talk. Call (713) 702-6401 or email [email protected].