Making a 1031 Exchange when Transferring Investment Property
Many investors in commercial real estate are unaware of the enormous benefits of “1031 exchanges” under a tax code that allows the owner of an investment property to swap it for another property of higher value while deferring the capital gains tax. As of this writing, the law allows 1031 exchanges to be used more than once, allowing you to daisy chain the deferral of taxes, and build wealth that can be passed down to heirs—making 1031s a crucial part of estate planning, especially for high net-worth families.
As attorneys, we can advise and facilitate on all aspects of a 1031 exchange, including possibly complex estate issues. We also track ongoing changes to these dynamic laws, as well as related legal opinions.
Let’s take Ann and Mike as an example. This couple is in their mid-sixties with four children. They wisely bought a 20-unit, multi-family, rent-controlled building a decade ago as an investment. It’s been profitable and the equity has soared, but after 10 years, they’ve had enough of tenants complaining about leaky toilets, broken windows, and noisy neighbors. Ann and Mike still want to own rental property to fund their retirement and create a legacy for their children, but at this stage of life they just want to invest in a property where they simply collect a check each month. No repairs, no complaints—and they don’t even want to deal with shopping for a new building.
At the same time, Ann and Mike don’t want to pay the enormous capital gains tax bill that might be owed when they sell off the old property.
Through our affiliation with a major real estate brokerage, CunninghamLegal can not only find Ann and Mike a property where they can just collect checks, but we can also make sure they defer the capital gains taxes on the sale of their old building by using a 1031 exchange. The couple’s Estate Plan and Living Trust will be adjusted, and CunninghamLegal will guide the couple through the 1031 time limits they need to follow in order to take advantage of the benefits. We may also take actions like creating a family LLC to control liability, protect the precious new asset, and potentially limit property taxes.
As a mid-size firm, CunninghamLegal also offers the kind of longevity not found with solo attorneys. When Ann and Mike are gone, our firm can administer their trust to make sure the four kids understand and benefit equally from their parents hard work and success—without conflict and hassles.
Saving Commissions on a Simple Real Estate Deal
The standard commission for a real estate agent in California is about 5%-6%, a fee that includes the responsibilities of finding a buyer and then guiding the sale through to completion.
But again, what if you already have a buyer?
Grace is a successful businesswoman who wants to sell a small commercial building she owns that’s worth about $2 million. One of Grace’s tenants has grown to occupy the whole building, and they’d now like to buy the property outright. Together, both parties decide to move forward. All they need is someone to shepherd the transaction through and advise them on minimizing any tax consequences from the sale.
If Grace goes to a broker, she will most likely have to pay their regular 5% commission even though the broker isn’t really doing the bulk of the work. That’s basically the same as paying someone to paint your entire house when all you need is a little touch up.
At CunninghamLegal, as long as the transaction is over $1 million, we charge just 1.5% for facilitating private real estate deals when the seller already has a buyer. Given the difference between a commission of 1.5% and the standard 5% on $2 million, we can save Grace about $70,000 on the deal! We’ll also make sure the proper tax and estate issues are discussed.
Complex, High-Stakes Real Estate Transactions Need Special Legal Expertise
Here’s a more complicated example.
Let’s say Barbara and her brother, Ben, inherited a mobile home park just outside Los Angeles. Ben owns a controlling 55% interest worth roughly $15 million; Barbara owns 45% worth roughly $12 million. Ben now wants to buy Barbara out to avoid future hassles, and Barbara agrees.
The issue? Both Barbara and Ben have children, and the grandparents had placed the mobile home park inside a “generation-skipping trust” to make sure the investment properly benefitted their grandchildren. This trust may or may not have been necessary, but it makes handling the transaction extraordinary complicated, and frankly, above the pay grade—or patience level—of most agents.
Also, consider that the park was purchased by Barbara and Ben’s parents 30 years ago at just $1 million. That means there’s been a gain of $29 million. In other words, high stakes from a capital gains and property tax perspective. This purchase that needs to be handled by someone who really knows what they’re doing—not just in real estate, but in tax and estate planning as well!
And remember—in this case, there’s already a buyer, so they don’t have to hire a full-service agent just to make a deal happen. We can potentially save these clients over a million dollars on brokerage fees alone, not to mention preserve family harmony and prevent legal headaches far into the future.
Complex Real Estate Transactions Outside Your Area
Even with modern technology, it’s not always easy to conduct business outside our own region, especially if it’s a complicated task like selling a house after a loss.
Let’s take “Doris, Heidi, and Sol” as an example. Doris dies at 98, leaving her daughter Heidi an apartment in Los Angeles, while leaving a 30-acre ranch in Fresno to both Heidi and her brother Sol. Heidi is the Trustee and Executor, but she has spent little time in Fresno, and knows nothing about ranch land. Between all there is to take care of after a death, her own busy career, a brother who wants to know when his share of the money will be available, and a short time frame during which she needs to sell the property, there’s no way Heidi can research selling a ranch in Fresno! Through our affiliation with a major brokerage, we can easily find someone to knowledgeably list the ranch and have it sold at a good price with minimal hassle for Heidi, while handling all the Estate and Successor Trustee issues to make sure Sol properly benefits, as well.