ALTERNATIVES TO 1031 EXCHANGES

THAT CAN DEFER TAXATION

Installment Sales, Structured Sales & Deferred Sales Trusts

Internal Revenue Code (IRC) Section 1031 tax deferred exchanges provide many benefits to real estate sellers. Taxpayers selling real estate may want to explore with their tax and/or legal advisors the advantages and disadvantages of other methods of selling appreciated property.

INSTALLMENT SALE

IRC §453 (the installment sale rules) allows a seller who sells appreciated property on an installment basis to defer paying capital gain taxes to future tax years when installment payments are actually received. This strategy is often referred to as seller financing. The advantage of seller financing is deferring recognition of taxable gain to later years. The disadvantage of this method is the risk the buyer will default in making the payments and the seller will need to foreclose on the property.

STRUCTURED SALE

A structured sale is similar to seller financing, except the buyer is not making the payments to the seller of the relinquished property. The seller assigns the buyer’s note to a financial institution (usually a large insurance company). The seller receives payments in the form of a Single Premium Immediate Annuity (SPIA). The SPIA obligates the financial institution to pay the seller over the seller’s lifetime. The main advantage to the seller is that the payment obligation is trasferred from the buyer to the financial institution thereby eliminating the risk of the buyer’s default. Disadvantages include market risks (payments do not increase relative to inflation) and, in most cases, the annuity payments cease upon the seller’s death leaving nothing for the beneficiaries.

DEFERRED SALES TRUST

A Deferred Sales Trust (DST) is similar to a structured sale, except that an irrevocable trust is formed and substituted for the financial institution. One advantage of a DST is that it generates a stream of payments that spread the tax liability over time. Disadvantages of a DST include the need to use an independent trustee to manage the trust and the assets remaining in the DST are subject to estate taxes at death in some cases. A DST can invest its funds into a variety of prudent investments including stocks, bonds, mutual funds, annuities and real estate.

STEPS INVOLVED IN CREATING A DST

• Establish the DST before the asset or property is sold.
• Transfer ownership of the asset to the DST.
• The DST provides a document to the seller that explains the terms of the underlying installment sale ands specifies the payments of principal and income.
• The assets or property are sold by the DST to a third-party buyer.