Real Estate, 1031,and Royalty Trusts

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Sep 22, 2005 1:48 pm

An idea being researched by my team in recent weeks is the strategy of selling highly appreciated real estate, and deferring the gains above the 500K exclusion by placing the proceeds into a Royalty Trust. By using a royalty trust and investing the total proceeds in a closed end fund, the client is deferring ALL taxes that would need to be paid, difersifying their holdings, and earning a nice yield. We have been researching a utilities closed end fund thats traded on NYSE, and currently has a yield of 8-9%. Granted, taxes must be paid on the income received, but its a much better alternative to selling a home and paying gains on the appreication. Living in Southern California, this idea may generate some HUGE production. Some of our clients here have 80% of their net worth in real estate, and it may benefit them to start peeling off some of their properties.


Thoughts? Comments? This idea could be a boon to us all.

Sep 22, 2005 2:29 pm

I'm no final authority here, but don't you need to reinvest in something at least somewhat similar?  I could see a real estate trust, but I'm still trying to figure out how a closed-end utility fund will get past the like-kind exchange hurdle?

Sep 22, 2005 3:31 pm

Indyone is right!


 It will be taxable, 1031 exchanges need to be like kind. I have walked clients through several of these. Here is a tip. We 1035 into another property hold that property a little over a year and sell it we get the step up but we do pay taxes on the gain over the 1031 basis. They are taxed as short term gains. But we side step recapture of depreciation. This is one of the benifits of doing tax returns for clients and having excess to tax software and a CPA in my office!


Sep 22, 2005 3:43 pm

green- thats a solid idea. its a good conversation to have with some clients. also a good way to start dialogue on something pertinent on many of our clients minds.


indy- you are right, the exchange does need to be into something similar, but one cpa we work with seems to think that this strategy still passes muster with the irs. its a careful topic, since we all cannot act as tax advisors. we have made inquiries all the way up the firm, and they are looking into it. so when we get back something, i will let all the ML guys know!

Sep 22, 2005 3:55 pm

Thanks for sharing fellas.

Sep 23, 2005 9:48 am
blarmston:

We have been researching a utilities closed end fund thats traded on NYSE, and currently has a yield of 8-9%.



I'd like to hear more about the long term viability of this sort of closed end paying what seems to be  unsustainable yields....

Sep 23, 2005 8:27 pm

I'd like to hear more about the long term viability of this sort of closed end paying what seems to be  unsustainable yields....


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Unsustainable yields on closed-end funds normally mean that they are leveraged, i.e., the fund manager has borrowed money to buy high yielding bonds/stocks to juice the returns. For example: borrow at 3% to buy stocks/bonds yielding 6%. However, such leveraging is a killer in rising rate environments.


Such yields can also mean the closed-end fund contains securities of poor quality, i.e., junk


Normally, just checking the fact sheet on the fund will disclose whether it's leveraged and a percentage breakdown of credit quality: AAA, AA, A, etc.


Should you consider incorporating these types of securities in your clients' accounts? I wouldn't. In fact, I look for these types of investments in my prospects' accounts. When I explain what they are, how they work, and the risks involved; I usually get a new client.


In my experience, it's much harder to lose a client invested in high quality securities. Though they usually have lower yields, the peace of mind for the client (and you) is priceless!

Sep 28, 2005 1:01 pm

I prefer the private annuity trust route to defer capital gains on real estate or a 10-31 and using the proceeds to purchase TIC (tennats-in-common) securities (which are qualified for 10-31 purposes) and are typically available through any property management company that offers REITS.


Another thought process is the private annuity trust / 10-31 exchange combination.  Using this strategy a seller can go from a $1,000,000 piece of property to a $500,000 piece of property and defer their capital gains.  The portion that they wish to sell outright is sold by the trust through the private annuity and the other portion is done through a 10-31 exchange to find a comparable replacement property.


Do a Google search for more detailed information.



Sep 28, 2005 6:16 pm

good stuff by all.

Oct 13, 2005 7:29 am

What do guys think of Inland Western Retail Realty trust?

Oct 13, 2005 7:13 pm

metellnoname wrote:


"Using this strategy a seller can go from a $1,000,000 piece of property to a $500,000 piece of property and defer their capital gains"


This is true for married couples and their primary residence. What about commercial investment property?  Can you still get the 500K exclusion?