Tuesday November 12, 2019
Case of the Week
Exit Strategies for Real Estate Investors, Part 7
Case:Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. By far, Karl was most successful with real estate investments. It was definitely his passion.
Amazingly, Karl continued to buy and sell real estate at the age of 85. For instance, about three months ago, Karl discovered a great investment property. It was a "fixer-upper" commercial building in a great area. While other nearby buildings sold for over $2 million, the seller needed to sell quickly and was asking just $1 million.
The condition of the building turned many buyers away. It was being sold "as-is," but Karl was not deterred. He could see great potential with the building and knew it would not take much to get it to market condition. Therefore, Karl swooped in, bought the building for $1 million and instantly hired contractors to refurbish the place.
After three months of hard work refurbishing the building, the place looked like new! In the end, Karl invested $250,000 in the building bringing his total investment in the property to $1.25 million. One month after the completion of the work, Karl was contacted informally by a company that expressed an interest in the building – a $2 million interest! This was no surprise to Karl. He knew the building was another great buy.
There was one downside to the idea of selling, however. Karl held the property only four months, which meant the gain from the sale would be short-term capital gain. In other words, the applicable tax rate would be 37%, not 23.8%. Karl cringed at the thought of paying much of his gain to the government. At the same time, Karl knew the hot real estate market would not last forever and could change directions in the next year. So, although Karl wanted the 23.8% tax rate, Karl did not want to risk holding the property another eight months.
Karl decided to implement a "Sale and FLIP CRUT" exit strategy (See Case Study Part 6). In other words, he wanted to sell and pay no tax. However, there still was one point of concern.
Karl's advisors noted that once the undivided interest in the property was transferred into the FLIP CRUT, the FLIP CRUT should list and sell the entire property. In short, it would be advisable for the trust to handle the sale of Karl's portion as well.
Question:Karl wondered why this step was important. Similarly, Karl questioned whether this step was necessary.
Solution:Although hundreds of split gifts are completed annually and the IRS to date has not contested the concept of split transfers on any of these transactions, it is prudent to evaluate options that increase the safety of prospective transactions. While no strategy short of a private letter ruling for a specific transfer promises 100% safety, several actions may increase safety levels for a split gift. Here are some "Safety Recommendations for Split Gifts."
Published May 17, 2019