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Are Family Offices Leaving Money on the Table by Neglecting CRE Tax Benefits?

Family offices might be bypassing several common tax-saving strategies when investing in real estate.

Some family offices might be at a severe disadvantage when it comes to taking advantage of tax benefits derived from commercial real estate investments.

A recent survey by Family Office Real Estate Magazine indicates family offices are largely bypassing several common tax strategies tied to buying and selling commercial real estate. For example:

  • 67.7 percent of the 102 family offices in the U.S. that were surveyed didn’t undertake any 1031 exchanges last year. 
  • 81.8 percent didn’t complete any Delaware Statutory Trusts (DSTs) last year. DSTs are a type of 1031 exchange. 
  • Only 18 percent planned to invest in Opportunity Zones

Those findings conflict with the desire of most family offices (55.8 percent, according to the magazine’s survey) to reap tax benefits from investing in real estate.

 If the typical family single-family or multi-family office—with $808 million in assets under management, according to a recent global survey—were to realize a 1 percent lift in property-related tax benefits as a share of total assets, the windfall would exceed $8 million. That’s a crude calculation, to be sure, but it offers a rough sense of the potential financial boost from fully capitalizing on the myriad tax benefits linked to real estate investing.

Family-office professional DJ Van Keuren, publisher of Family Office Real Estate Magazine, says a lack of knowledge keeps some family offices from reaping tax benefits through vehicles like 1031 exchanges, DSTs and Opportunity Zones.

“Real estate is the second-highest area of wealth creation for families outside their initial business. It can also be used for generational wealth creation and to provide an income stream down the road,” Van Keuren says. “Generational wealth creation, combined with the tax benefits, makes real estate an ideal tax-planning tool for family offices.”

Van Keuren says 1031 exchanges, including DSTs, represent one of the most important tax-planning devices in commercial real estate. As outlined by the IRS, a 1031 exchange lets an investor put off paying taxes on the gains from a property sale if the proceeds are reinvested in a similar property as part of what’s called a “like-kind exchange,” or swap. The IRS stresses that these gains are tax-deferred but not tax-free.

As for Opportunity Zones, the general lack of interest among family offices in these tax-saving structures might be due primarily to uncertainty about federal regulations governing them, according to the Family Office Real Estate Magazine. The Opportunity Zone Program, established under the federal Tax Cuts and Jobs Act of 2017, provides sizeable capital-gains tax breaks for value-add investments in properties located in economically-distressed areas.

Professional services firm KPMG says that in order to maximize the potential tax benefits, investment of capital gains in Opportunity Zone funds should be completed by Dec. 31, 2019.

But family offices must weigh tax benefits as part of a broad view of a real estate portfolio, according to Kenneth Munkacy is senior managing director of Boston-based Kingbird Investment Management LLC, the newly-rebranded real estate arm of Puerto Rico-based family office Grupo Ferré Rangel.

“Just as you evaluate fees with the sponsors, you need to understand tax implications for a given investment to ensure you have an accurate picture of the net returns,” Munkacy says. “Depending on the asset, there may be tax benefits that come with certain types of real estate investment, such as investing in historic buildings or affordable housing.”

Likening this to a medical consultation, Munkacy says tax planning in commercial real estate investing goes beyond tapping the expertise of a tax attorney.

“You see different specialists for different aspects of your health and seek second opinions when appropriate. Talking to a tax lawyer is different from talking to an accountant, wealth management professional or financial planner,” Munkacy says. “When you put the input from various sources together, you have a more robust picture and can make a more informed decision.”

If transferring generational wealth is a key goal of a family office, it’s just as critical to ensure the overall structure of a real estate deal, including tax implications, is correct as it is to ensure the underlying fundamentals of the investment are solid, says Wil Ward, partner and managing director of direct investments at TwinFocus Capital Partners LLC, a multi-family office based in Boston.

Aside from income taxes, a family office should examine estate and gift taxes, interest deductions, capital expenditures, deprecation and other tax-oriented facets of real estate investing, he says.

Beyond returns, taxes and regulations sit behind two other deciding factors when family offices around the world ponder investing in real estate, according to the 2018 Global Family Office Report, published by investment bank UBS and research firm Campden Wealth Ltd. Forty-one percent of family offices surveyed for the report picked taxes and regulations as the most important factor, preceded by location (79 percent) and cost (50 percent).

This doesn’t mean, though, that family offices overlook tax strategies entirely. In the UBS-Campden Wealth report, one family office executive in North America noted that the current generation involved in his family office is “very aggressive” about avoiding taxes.

“They have expatriated most of their assets from the United States, hold dual citizenship passports with known tax havens, and employ accountants who [use] very aggressive forms of tax filing,” the report says.

When asked how much money they’d pocketed through this approach, the executive responded: “In the order of millions.”

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