With high valuations and many baby boomers preparing or retiring, many investment property owners may be rethinking their real estate ownership strategy.
That’s a big deal for many near-retirement and retired people considering there’s an estimated $6.4 trillion in net worth that people over 55 have tied up in high-rise buildings. placement, according to estimates from Realized, a platform that provides real estate wealth solutions.
Especially coming out of the pandemic, many seniors may no longer want to deal with homeownership, having to perform tasks such as rent collection and property management, says Rob Johnson, head of wealth management at Realized.
While now might be the perfect time to exit at such high valuations, there are several things to consider before you jump in and sell. Here’s what financial advisors tell clients.
Think ahead. Anyone considering selling an investment property should consult with tax, finance and real estate professionals before making a decision. Ideally, these discussions will take place before the owner retires to allow enough time to properly strategize, says Nell Cordick, senior vice president and financial advisor at Bogart Wealth, which has offices in Virginia and Texas. .
A major factor in these discussions should be taxes. “When people haven’t done the proper tax planning ahead of time, they’re shocked at the tax results of selling an investment property. What they thought was their net [proceeds from the sale] is much, much lower because of the tax implications,” she says.
From a tax perspective, you’ll want to consider the ramifications of selling the property outright versus other tax-efficient options such as a 1031 exchange, which offers several benefits, but also requires strict adherence to IRS regulations.
The timing of a sale can also be important from a tax perspective. Selling in a year when other sources of income are weak could be a good option, she says. If you’re over 63, you’ll want to consider what effect, if any, a sale will have on your health insurance bracket, she adds.
Beyond taxes. It’s also important to understand how a sale fits into a client’s overall real estate strategy. Some owners, for example, may choose to sell high, even with the tax consequences, because they think there will be a correction where they can buy low and then go through the whole process again, Cordick says. Others might just want to stop owning an investment property and are willing to accept the tax consequences to avoid emotional hassle, she says.
Here are some questions advisors should ask, says Jody King, director of wealth planning at Boston-based Fiduciary Trust.
Does the customer want to continue to be an active owner or does he prefer a more passive role? If they love working in property management, how attached are they to that particular property? Will it hold its value or would it be advisable to sell now and find another property in a more desirable location? How important is cash flow to your retirement, and how will you replace it, if it is necessary to maintain your lifestyle?
Explore the possibilities. For clients who wish to remain in the investment property business, there may be several options. For those wishing to manage their tax liability, one option could be to sell their current investment property and purchase another through a 1031 exchange. This strategy allows investors to defer tax on capital gains when selling their investment property, if strict rules are followed. For example, they must identify a replacement good within 45 days and make the exchange within 180 days.
For owners who wish to take a less active role, but still wish to enjoy the tax-deferred benefits of real estate ownership, there is the option of a Delaware Statutory Trust, or DST, which are portfolios of professionally managed commercial real estate. DSTs offer investors fractional ownership of commercial real estate, but all management responsibilities are given to a sponsor, says Johnson of Realized.
Some DSTs have one property, while others have more than 20 properties within their structure. Investors can also diversify by investing in multiple DSTs, he says. “Having a diversified portfolio in retirement is essential because you don’t want to take undue risks or focus your portfolio too much on one property,” he says.
Some clients may also consider selling their property and investing in an Opportunity Zone Fund, an investment program created by the Tax Cuts and JOBS Act of 2017 to provide tax benefits to certain investments in low-income areas. Investors funnel their gain on the property sold into the Opportunity Zone fund, where it will increase tax-deferred until 2026, said Brad Levin, managing director and senior wealth adviser at The Colony Group. There are many funds available of this nature set up by real estate investment companies, he says.
Another option for clients with charitable inclinations is to transfer the property before it is sold to a charitable remainder trust. The gain made on the sale is then exempt from capital gains tax. The proceeds can be reinvested and the investor receives income from the trust throughout their lifetime, and when the individual dies, whatever remains goes to charity, Levin says.
“It’s not just about saving tax or not. There are a lot of different elements, and you have to understand the whole picture before you can give advice,” says King of Fiduciary Trust.
Keep in mind that emotional attachments to properties can change the image. Does the client wish to keep the property in the family? And if so, what is the most appropriate way to initiate a change of ownership? How important is cash flow to your retirement, and how will you replace it, if it is necessary to maintain your lifestyle?
Although there is no one-size-fits-all solution, advisors can help clients weigh the pros and cons of various options. “It’s the advisor’s job to present the options and allow the client to make decisions based on those options,” says King.
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