Escape the Rental Property Tax Trap How to
Planting Seeds For the Next Generation
When you plant seeds in your vegetable garden in the spring, you don’t expect fresh tomatoes, squash, and zucchini to spring out of the ground the very next day. That would be crazy! Everyone knows vegetable gardens take months of sun, water, and good soil to produce the best summer vegetables. That’s why you don’t wait until the last minute to plant your seeds. Unsurprisingly, the same goes for planning your estate. While nobody likes to consider their own mortality, it’s better to be prepared for the inevitable before it happens rather than be caught off guard when it does happen. With that in mind, the next question might be when you should start estate planning. The short answer is it’s never too early to start planning. Whether you’re 65 and you have kids and grandkids to think about, or you’re 25 and you just have a savings account with $5,000, the time to start estate planning is now. When you’re younger, you’ll most likely have fewer assets for which to find beneficiaries. That prospect of having less work to do might be incentive enough for some of you to get the planning process started as early as possible, but you’ll have to do some parts of the estate planning process regardless of age. No matter how many assets you have, you should still name a durable power of attorney and a health care proxy. You should also name beneficiaries for any savings and retirement accounts you have. Young estate planners would also benefit from at least having a will. Every generation benefits from what the previous generation leaves behind but only if they leave it well. If you plant seeds in a garden but don’t bother to water them or make sure they have proper sunlight, your plants probably won’t grow very well. At Phillips & Blow, we’ll make sure your seeds are planted well and properly cared for. Give us a call at (303) 741-2400.
Owning a rental property (residential or commercial) can be a good investment and income option. However, a downside is that you will often face significant capital gains and depreciation recapture taxes when you sell the property. If you can hold the property until you die, the taxes go away, but what if you can’t wait or are just tired of the management hassle of a rental property? Section 1031 “like-kind” exchanges can allow an owner to sell a property and immediately reinvest the proceeds in another “like-kind” property without triggering the taxation. Even though the rules are rather specific as to timing, you remain as an active manager of the new rental property. Good news! In recent years, the IRS has approved the use of a specific type of trust to receive 1031 funds and then allow passive ownership (i.e., you don’t have to manage any more than you would with mutual funds or a real estate investment trust). These trusts usually pay you about a 5% annual return (subject to income taxation as any other source of income) as well as likely capital appreciation (depending on the specific property chosen and the overall market conditions). This way, you earn income from the entire value of the property, including the 30% or so that otherwise would have gone to the IRS upon a traditional sale. These trusts typically hold the underlying property for 3–10 years (e.g., commercial version of fix and flip). You can then take the money and pay the taxes or reinvest into another such trust and defer the taxes again. This way you can get lifetime income (including income generated on the money that otherwise would go to taxes), hold this, or some other trust until you die, and thus completely avoid the capital gains and depreciation recapture taxes altogether and let 100% of the value go to your heirs.
If you or anyone you know has a rental property and are interested in learning about this opportunity, give us a call.
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Trusts • Probate • Long-Term Care Planning • Elder Law
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