Calculate Tax Liability For Selling Your Investment Property

Even in a thriving seller's market, one aspect that concerns investment property owners is the burden of capital gains taxes. For instance, in California, owners of investment properties can face tax rates as high as 42.1% upon the sale of their property. Due to the substantial tax liability in various states, many investors are now exploring tax-deferral strategies. In this case, the property owner should consider utilizing a 1031 Exchange in California.

Comprehending Tax Liability

Tax Liability = Capital Gains Tax + Depreciation Recapture Tax

As an experienced 1031 Exchange professional, one of our primary tasks when assisting a client is to help them grasp their tax liability. Tax liability stemming from the sale of investment real estate encompasses more than just the federal capital gains tax.

It represents the total sum of taxes owed when an investment property is sold. Apart from Federal Capital Gains Tax (ranging from 15% to 20%), the property owner may also be subject to State Capital Gains Tax (ranging from 0% to 13.3%), Depreciation Recapture Tax (25%), and Net Investment Income Tax (3.8%).

Five Steps to Calculate Your Tax Liability

Young woman using calculator to manage business expenses highlighting the importance of a 1031 exchange in calculating tax liability

When estimating your tax liability after selling an asset, federal and state tax authorities consider the taxable gain rather than the gross proceeds from the property sale. To determine the total tax liability, follow these five steps:

Step 1: Estimate the Net Sales Proceeds

Begin by establishing the fair market value of the investment property or the listing price if you put the property on the market. There are various methods to calculate the sales price, but the two most common approaches are the income method and the comparable sales method.

For the income method, divide the current or projected net operating income (NOI) by the desired capitalization rate (cap rate).

For the comparable sales method, investors assess the value based on recent sales of comparable properties in the local area, considering factors such as size and quality.

Smaller properties and single-family rentals usually rely on the comparable sales method, while larger properties use the net operating income to determine value. Many investors seek the assistance of an experienced broker to establish a justifiable sales price.

Step 2: Estimate the Tax Basis

Tax basis, or remaining basis, represents the total capital invested and capitalized in the asset, which includes the purchase price, closing costs, and capitalized improvements, minus the accumulated depreciation. To calculate the tax basis, consider the following example:

Assuming you purchased the property for $850,000 and invested $200,000 in capital improvements. Additionally, you have claimed $750,000 in depreciation over the ownership period. In this case, your remaining basis would be $300,000. Note that there are certain limitations regarding which items can be included in the tax basis.

For instance, mortgage insurance premiums and routine maintenance costs are typically excluded. It is advisable to consult with a tax advisor to determine the current remaining basis of your property, taking into account adjustments for capital improvements and tax deductions.

Increasing the Tax Basis:

Property owners have the opportunity to increase their tax basis by making investments in the property through capitalized improvements. These improvements, such as a new kitchen, roof, or an addition, along with financing expenses, contribute to increasing the investment in the property. When selling the property, these capitalized improvements are subtracted from the net sales proceeds to determine the property's gain.

While certain costs like legal fees, management expenses, and small repairs are treated as operating expenses and not capitalized, expenses for capitalized improvements provide owners with flexibility to increase the tax basis of the asset, rather than deducting them as operating expenses in the current year. The costs of capital improvements can vary widely, offering owners the ability to adjust the tax basis accordingly.

Decreasing the Tax Basis:

Owners of investment real estate that includes a building or structure need to decrease the property's tax basis, which affects the calculation of the second form of gain known as "depreciation recapture." The primary method to decrease the tax basis is through an annual depreciation deduction. This deduction is subtracted from the tax basis each year and is treated as a tax expense that offsets income. However, it is important to note that depreciation is eventually recaptured at the time of sale.

Despite the initial decrease in tax basis and the subsequent increase in tax costs, the depreciation deduction reduces the investor's annual taxable income and lowers the income tax due during the ownership years. It's worth mentioning that annual depreciation is mandatory, and depreciation recapture is charged based on the total amount of available depreciation throughout the ownership period, regardless of whether depreciation expenses were recorded. Additionally, easements, certain insurance reimbursements, and other tax deductions like personal property deductions can also contribute to decreasing the tax basis.

Step 3: Calculate Taxable Gain

The taxable gain represents the realized return or profit from the sale of an asset. It is derived by subtracting the original tax basis (pre-depreciation) from the net sales proceeds. Tax authorities such as the IRS and Franchise Tax Board utilize the taxable gain figure to determine the capital gains tax. To calculate the taxable gain, subtract the original tax basis from the net sale proceeds.

Continuing with the previous example, assuming your original tax basis is $1,050,000 and the net proceeds from the property sale amount to $3,250,000, the taxable gain would be $2,200,000. The second part of the tax liability is calculated based on the amount of accumulated depreciation taken throughout the ownership period, referred to as accumulated depreciation. In the given scenario, this amount is $750,000.

Step 4: Determine Your Filing Status

Your capital gains tax rate is determined by factors such as your income, tax filing status, the state where you pay income taxes, and the location of the property being sold. Various tax authorities, including the IRS, state governments, and some local governments, impose capital gains taxes on investment property sales, thereby impacting the overall tax rate and increasing your tax obligation.

At the federal level, the capital gains tax rate is as follows: 0% for investors with an annual income (including gains from asset sales) below $40,000; 15% for investors with an annual income ranging from $40,001 to $441,450; and 20% for investors with an annual income exceeding $441,451.

Additionally, most state tax authorities also levy a capital gains tax, with rates ranging from 0% to 13.3%. California stands at the top with a 13.3% capital gains tax rate, while states such as Texas, Washington, and Florida do not impose state capital gains taxes.

Step 5: Calculate the Capital Gains Tax

Hand using a calculator with passbook and house model illustrating how a 1031 exchange can help defer tax liability

The capital gains tax is calculated based on the taxable gain, considering the tax rates determined by your income and filing status. There are four main categories of property tax: federal capital gains tax, state and local capital gains tax, depreciation recapture tax, and net investment tax.

For federal and state capital gains taxes, the taxable gain is subject to the applicable tax rates. In the example mentioned earlier, a California property owner with a taxable gain of $2,200,000 would owe 20% in federal capital gains tax and 13.3% in state capital gains tax, resulting in a total capital gains tax of $732,600.

Individuals with significant investment and rental income may also be subject to an additional 3.8% net investment tax, which is part of the Affordable Care Act and is added on top of the capital gains rate. Thus, the total capital gains tax bill in California would be 37.1% or $816,200 in the given example. It is important to note that this example specifically pertains to properties and taxpayers located in California, which has the highest capital gains tax rate in the country.

In addition to capital gains taxes, investors are also required to pay depreciation recapture tax. Depreciation deductions are taken annually to offset rental income. These deductions not only reduce the investor's annual tax liability but also decrease the remaining tax basis of the property. When selling the asset at a profit, the investor is required to repay those deductions, which is known as depreciation recapture.

At the federal level, the tax rate for depreciation recapture is a flat rate of 25%. It can also include up to 13.3% for state income tax and be subject to an additional 3.8% net investment income tax. While capital gains tax is calculated based on the taxable gain, depreciation recapture tax is calculated based on the accumulated depreciation during the investor's ownership. Based on the example with $750,000 of accumulated depreciation, the depreciation recapture tax in this scenario could be as high as $315,750.

Deferring Capital Gains Tax with a 1031 Exchange

Real estate investors have a valuable opportunity to defer, reduce, and potentially eliminate capital gains taxes through a strategy called a 1031 Exchange, also known as a "like-kind" exchange. This type of exchange, authorized under Section 1031 of the U.S. Internal Revenue Code, allows real estate investors to defer their tax liability when selling an investment property. In order to defer capital gains taxes, investors must reinvest the proceeds from the sale into like-kind investment property that has equal or greater value.

The term "like-kind" refers to any real estate that is of the same nature or class, rather than the same quality or property type. Essentially, this means that investors can exchange one investment real estate asset for another, as long as it falls under the category of like-kind property. It's important to note that personal residences do not qualify for a 1031 Exchange, as the exchange is limited to investment real estate assets.

The Rules for a 1031 Exchange

A 1031 Exchange is a powerful tool for deferring capital gains, depreciation recapture, and net investment income taxes after selling an asset. However, these exchanges can be complex transactions, and it is crucial to comply with the rules set forth by the IRS. Failure to adhere to these rules can result in a failed exchange or a partial exchange, leading to potential tax liabilities. Before proceeding with a 1031 Exchange, investors should familiarize themselves with the following primary rules:

Improving Cash Flow Potential with a 1031 Exchange

In addition to the tax savings, a 1031 Exchange offers the potential to enhance cash flow and appreciation by allowing the reinvestment of proceeds. Let's consider the example where the investor's total tax liability is $1,131,950. If the post-tax proceeds of $2,118,050 were reinvested and earned a 5% return, it would generate an annual income of $105,903.

However, by opting for a 1031 Exchange, the investor would have $3,250,000 available for reinvestment. Assuming the same 5% return, the exchanged proceeds would generate an annual cash flow of $162,500. This represents a significant difference in cash flow potential, exceeding $56,500. This is one of the primary benefits of 1031 Exchanges – the ability to keep all your equity working for you, generating income and potential appreciation.

By deferring capital gains tax and reinvesting the full sales proceeds into a new property, investors have the opportunity to leverage a larger amount of capital, potentially resulting in higher cash flow and increased investment returns. This enhanced cash flow potential is a key advantage of utilizing a 1031 Exchange as part of a strategic real estate investment plan.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only. All scenarios provided for herein are hypothetical illustrations of mathematical principals only, not a promise of performance or success.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

Is a 1031 Exchange Considered an Arm's Length Transaction?

In a 1031 exchange, investors can defer capital gains taxes by reinvesting the proceeds from the sale of one property into another. However, to qualify for the tax deferral, investors must follow strict rules, including the requirement for an arm's length transaction. An arm's length transaction means that the parties involved are unrelated and act in their own best interests.

To ensure compliance, investors use a Qualified Intermediary (QI) who holds the proceeds from the initial sale in a separate account. The QI must be an independent party and cannot have a relationship with the investor. Additionally, the IRS imposes restrictions on related-party transactions within a 1031 exchange, preventing the sale of acquired properties to related parties for at least two years.

This rule aims to prevent basis-shifting and the avoidance of capital gains recognition by trading low-cost basis properties for high-cost basis properties with related parties.

How Do Arm's Length Rules Impact 1031 Exchanges?

To maintain the arm's length nature of the transaction, investors must utilize a Qualified Intermediary (QI), also known as an Exchange Accommodator. The QI acts as an independent third party who facilitates the exchange, holds the proceeds from the initial sale, and ensures that the transaction adheres to the necessary rules and timelines.

retirement-planning-real-estate-investment-opportunities-strategies-tax-deferral-beneficial-to-both-parties

One crucial rule in a 1031 exchange is the two-year holding period requirement. If either party involved in the exchange sells the property within two years of the exchange, the IRS will disqualify the transaction, resulting in the recognition of capital gains and potential tax liabilities. This rule is in place to prevent taxpayers from abusing the exchange by quickly selling the acquired property for immediate financial gains.

However, there are exceptions to the two-year rule. The IRS acknowledges that certain circumstances may warrant an early sale without disqualifying the exchange. These exceptions include:

●     Death of either party: If either the buyer or the seller passes away within the two-year holding period, the transaction will not be disqualified. The death of a party is considered an involuntary conversion and falls under an exception to the rule.

●     Involuntary conversion: In the event of an involuntary conversion, such as property damage or destruction by fire, natural disaster, or condemnation, the exchange may be exempt from the two-year rule. The taxpayer must prove that the sale of the property was a result of an unforeseen and involuntary event.

●     Non-tax avoidance motivation: If the taxpayer can demonstrate that the motivation for selling the property within the two-year period was not primarily driven by tax avoidance purposes, the exchange may still be eligible for tax deferral. The burden of proof lies with the taxpayer to establish a legitimate non-tax-related reason for the early sale.

It is essential to consult with a qualified tax professional or an experienced intermediary to ensure compliance with the arm's length rules and to navigate any exceptions that may apply. By following the guidelines and exceptions provided by the IRS, investors can effectively leverage the benefits of a 1031 exchange while adhering to the required rules and timelines.

The Impact of the Arm's Length Requirement on Fair Market Value in 1031 Exchanges

The determination of Fair Market Value (FMV) is crucial in any real estate transaction. FMV represents the value of a property as determined by the marketplace, where an objective purchaser is willing to pay. To ensure that a transaction meets FMV standards, it must be conducted at arm's length, meaning both parties are unrelated and act independently.

In real estate, FMV is typically determined by analyzing recent sales of comparable properties in the same area. This approach helps establish a fair and objective value for the property. If comparable sales data is insufficient, an expert appraisal can be used as an alternative method to determine FMV.

However, if you sell your property to a relative or someone with a personal or business relationship, there is a risk that the transaction may not reflect FMV. This can occur when the seller has an interest in selling at a lower price, and the buyer has an interest in paying less than the property's actual worth. Such considerations can jeopardize the qualification of a 1031 exchange for deferring capital gains taxes.

Complying with the arm's length requirement is essential in 1031 exchanges to ensure that FMV is upheld. When parties involved in a transaction have a non-arm's length relationship, the transaction may raise concerns about whether it truly reflects FMV. By ensuring that 1031 exchange transactions adhere to FMV principles, investors can mitigate potential challenges related to qualification, particularly in non-arm's length situations. Seeking guidance from tax professionals and experts in real estate valuation can help ensure compliance with FMV standards and the arm's length requirement in 1031 exchanges.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

·     There’s no guarantee any strategy will be successful or achieve investment objectives;

·     All real estate investments have the potential to lose value during the life of the investments;

·     The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

·     All financed real estate investments have potential for foreclosure;

·     These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

·     If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

·     Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

 

How to Delay or Reduce Capital Gains Tax on a Business Sale


There are multiple strategies to minimize capital gains taxes while selling a business or asset. This article will explore two tax-efficient approaches for structuring a business sale: the Deferred Sales Trust and the Charitable Remainder Trust (CRT). Although they provide capital gains tax benefits, they have distinct purposes.

What is a Deferred Sales Trust?

A Deferred Sales Trust is utilized to postpone capital gains on asset or business sales. It is crucial to note that the DST should not be confused with a Delaware Statutory Trust (DST) as they are distinct entities.

To establish a Deferred Sales Trust, the investor or client sells an asset to a trust that is unrelated to them, and the trust becomes irrevocable. It is critical to ensure that the seller cannot be the trustee or beneficiary or have any control or ownership of the trust to prevent the IRS from classifying it as a "sham trust." This separation creates a third-party transaction, and a corporate trustee, usually an independent third party, manages the trust. The client may also choose an investment trustee in some cases.

Once a Deferred Sales Trust is established, it will operate based on the original agreement. As the client or grantor will have no control over the trust, it is vital to ensure that the trust is created precisely as intended, as it will not be possible to make any changes once established.

The trust sells the business to a third party and receives payment in cash, but from the client's perspective, the business is only sold to the trust. The trust will then make regular payments to the client. The tax deferment is achieved through an installment sale, as per the Internal Revenue Code 453.

The installment payments enable the capital gain to be proportionately spread out, and taxes are only applied to installments instead of a single lump sum sale. The client can specify the amount of the installment payments.

It is important to understand that a Deferred Sales Trust can only delay capital gains taxes and not recapture taxes.

A Deferred Sales Trust can have multiple beneficiaries, including family or charitable organizations. In the event of the grantor's passing, the beneficiaries receive the installment payments.

The trust can invest the proceeds from the sale of the asset, as per the agreements established during the creation of the trust.

However, it is crucial to note that a Deferred Sales Trust cannot be initiated if the investor is already under contract to sell their business, as it must be established before the sale of the asset or business.

methods-to-delay-or-minimize-capital-gains-tax-on-a-business-sale-FL-investment-strategies-wealth-management-Florida

What is a Charitable Remainder Trust (CRT)?

While Deferred Sales Trust and CRT share some similarities, a Charitable Remainder Trust (CRT) is a more suitable option for investors who aim to eventually donate their proceeds to a charity or foundation.

A CRT is a tax-exempt trust that is created when an owner donates an asset or business to the trust. The donor receives an immediate tax deduction for the value of the donation. However, the charity may not receive the proceeds for a long time.

The trust sells the business to a third party, and it is not taxed on the sale. However, any gain or ordinary income recognized in the sale is subject to taxation upon distribution to the grantor, i.e., the investor or business owner.

A Charitable Remainder Trust (CRT) has two distribution options: fixed or variable (unitrust). Once the distribution option is chosen, it cannot be changed, making the CRT similar to an annuity. Additionally, like a Deferred Sales Trust, a CRT is an irrevocable trust.

Unlike Deferred Sales Trust, a CRT also offers tax advantages on recapture taxes.

A CRT is not limited to charitable organizations; it can be a private foundation created by the donor, such as a family foundation. However, the donor cannot change their mind and donate to a non-charitable entity, like a family member. The donor receives tax-advantaged income from the CRT, resulting in significant initial and ongoing tax savings.

While the trust may not donate the proceeds to a charity right away, a charity will eventually receive the asset at some point.

To illustrate how a CRT works, consider an example: An investor donates their business, which is worth $1 million, to the trust. The full amount of $1 million goes into the CRT, and the client receives an immediate tax deduction for the amount donated. The trust then sells the business to a third party and invests the proceeds.

The investor can choose between two options for distributing the trust's income: a CRAT, which provides fixed payments, or a CRUT, which provides variable payments based on a percentage of the trust's value. In either case, the investor receives an annual distribution of 5% of the initial amount donated, until the charity eventually receives the remaining amount.

It's important to note that the payments cannot exceed 20 years. Also, the trust can be set up to benefit not just charities but also private foundations, as long as they are tax-exempt. Finally, the CRT offers tax advantages on recapture taxes and creates significant initial and ongoing tax savings for the donor.

A CRAT is a charitable remainder annuity trust that requires fixed dollar amount payments and must pay at least 5% of the initial value.

A CRUT is a charitable remainder unitrust that offers payments as a fixed percentage of all trust assets, ranging from 5-50%. While the percentage option may help hedge against inflation when trust assets increase, payments may decrease if trust assets decrease due to distributions.

Like a Deferred Sales Trust, the donor establishes the trust rules as long as they comply with the Internal Revenue Code. Once established, the trust rules cannot be changed due to the irrevocable nature of the trust.

Both the Deferred Sales Trust and CRT offer tax deferral options for the sale of a business or asset but require an attorney for proper setup. Failure to set up the trust correctly may result in costly penalties and interest, so it's best to work with an estate attorney with a strong tax background.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

Planning Correctly For A 1031 Exchange Into A DST

The recent uncertainty in the global stock market has many investors looking for more conservative and less volatile investments. On top of that, traditional investment instruments like stocks and bonds are similarly not looking very attractive because of their recent lackluster yield performances. Therefore, more and more investors are attracted to Real Estate Income Funds.

While Perch Wealth is best known for its expert-level knowledge of Delaware Statutory Trust & 1031 exchange investment strategies and opportunities, the company also has a great reputation for working with nationally recognized real estate sponsors to source and structure All-Cash/Debt-Free Real Estate Income Funds for accredited investors.

Now, any investor who is thinking about selling an investment property may look into a 1031 Exchange, which is a provision in the IRS code that allows for tax benefits. This exchange allows the sale of an investment property and the reinvestment of the proceeds into a similar property, postponing capital gains and other taxes until a later date.

However, the process must be completed within 180 days and the funds must be held with a Qualified Intermediary to maintain eligibility for the exchange. If the funds are touched during the process, the exchange becomes invalid and the taxes must be paid.

Tips To Get Ready For the Exchange

Likely the most challenging aspect of the 1031 exchange process is the initial 45-day identification period. During this period, investors must formally identify the property or properties they intend to purchase, and they must do so within a matter of 6 weeks.

To avoid tax liability, the identified property or properties must have equal or greater value than the relinquished property. There are two primary ways to identify properties: the 3 property rule, where up to 3 separate properties can be identified regardless of their value, or the 200% rule, where an unlimited number of properties can be identified as long as their combined value does not exceed 200% of the value of the relinquished property.

To summarize, investors should keep in mind that the 1031 Exchange process must be completed within 180 days, starting from the sale of the property and the escrowing of the proceeds with a Qualified Intermediary, and including the identification and closing of the new property. Additionally, the equity and debt of the new property should be equal or greater than the relinquished property.

Prepare For the 45-Day ID Period

To reduce stress during the 45-day identification period, it is recommended to start searching and selecting potential like-kind properties before officially closing on the relinquished property. This way, the 45-day time clock starts ticking after the identification process has already begun.

Delaware Statutory Trust (DST) properties offer a convenient option for 1031 Exchange investors as the underlying real estate is already acquired and owned by the trust, making the purchasing process quick and seamless. Additionally, DSTs can serve as a back-up or contingency plan in case the initial replacement property falls through.

While the Real Estate Sponsor Company may have completed their due diligence on a DST property, it is still important for investors to conduct their own research. It is recommended to review current DST properties offered on the www.perchwealth.com marketplace, and work with a Perch Wealth Registered Representative to evaluate the different options and strive to find the best solution for their specific situation. It is important to remember that each investor's needs are unique and the due diligence process is crucial to make an informed decision.

Starting the Exchange Selection Process

It is advisable to start the screening process for DST investments around 30 days before closing on the relinquished or downleg property. This is because DST offerings have a limited availability and are capped at a specific value, and once the last dollar is invested, the offering is no longer open for further investment.

Typically, DST offerings are available for purchase for 1-3 months, so starting the selection process too early may result in missed opportunities. By starting the process approximately 30 days before closing, investors will have a better chance of identifying viable options that they can reserve and invest in as soon as the funds become available, allowing them to complete the 1031 exchange efficiently and within the 45-day identification period.

By keeping these guidelines in mind, investors can greatly reduce stress associated with a 1031 exchange, and potentially start earning cash flow from their investments immediately. The quick and seamless purchase process of DSTs compared to traditional real estate transactions can be a big advantage.

For more information on the 1031 exchange and DST selection process, it is recommended to reach out to a Perch Wealth's Registered Representative or visit their website for more resources.

DISCLOSURES

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Where to Start When Planning Your Finances?

The question of identifying the initial move when it comes to planning your finances can be quite complex and may not have a one-size-fits-all answer. In fact, a group of financial experts were asked this very question by Forbes' Finance Council and they provided a variety of responses. Some of their suggestions include:

●     Having a clear understanding of what your final objective is.

●     Keeping a detailed record of your financial inflow and outflow.

●     Gaining insight into your overall financial income and expenses.

●     Adopting a diverse approach when it comes to managing your banking accounts.

●     Starting to invest in various options as soon as possible.

●     Keeping a close watch on your credit score.

Get yourself paid.

One of the age-old principles of financial management that has been advocated by many experts, is the idea of paying yourself first. While it may not be the initial step when it comes to financial planning, (there are arguments to be made for both understanding your current financial position and also having a clear vision of where you want to end up) paying yourself first is seen as an essential step towards achieving financial stability and reaching your financial goals.

This method involves prioritizing saving and investing by putting some money aside from your income before allocating the rest for expenses. It helps in creating a buffer and ensuring you have enough resources to save and invest, which are necessary for reaching your financial goals.

Start with the fundamentals.

A critical initial step in financial planning is identifying and defining your goals. We all have short-term and long-term aspirations, and your objectives may vary depending on

your current financial situation. Elaborating on your goals, therefore, should include an assessment of your present financial position.

For instance, consider a 35-year-old, recently married person with a combined income of $200,000, $50,000 in student loans, a car loan balance of $25,000, and no mortgage. This snapshot puts your present financial situation into perspective and enables you to evaluate how much you can currently allocate towards savings and investments.

Once you have established your current position, you can then begin to identify and prioritize your financial goals. Whether it be saving for retirement, paying off debt, saving for a down payment on a home, or building an emergency fund, setting specific and measurable financial objectives will help you focus on the steps you need to take to achieve them.

planning-your-finances-for-retirement-investment-strategy-1031-exchanges-Florida-FL

More than one adviser suggests simply cutting back on everyday expenses to increase the amount of money you can divert to your goals. For example, we are all aware of how much it costs to buy coffee at a fancy café compared to making it at home. But, we don't often consider the cumulative effect of that daily expense over the course of a month or year, especially when compounded with investment.

In fact, small changes such as this, when implemented consistently over time, can make a significant difference in the long run. Additionally, it's a good idea to review your expenses on a regular basis to ensure that you're not overspending on non-essential items, and that you're allocating your resources in a way that aligns with your financial objectives.

Once you have set your goals and identified areas where you can cut back on expenses, you can then begin to explore different saving and investing options that align with your goals and risk tolerance. This may include traditional savings accounts, mutual funds, stocks, bonds or real estate investments. It is important to remember that building wealth takes time and consistency, and your plan should be reviewed and adjusted as needed.

Ultimately, by taking the time to identify your goals and start with the basics, you will be well on your way to creating a solid financial plan that will serve you well in the years to come.

Be adaptable.

As you progress in your financial journey, your circumstances may change, for better or for worse. To stay on track, you need to be able to adjust your budget and your plan accordingly. This can include responding to external changes, such as changes in your income or expenses, as well as re-evaluating and updating your goals as they evolve over time.

For example, consider a young couple with a good income but limited investments, their immediate goals likely included buying their first home, saving for retirement, and other milestones, as well as establishing an investment portfolio.

However, as time goes by, their situation and goals may change. They may have children and want to assist with their future educational plans. They may need a larger home and decide to turn their primary residence into a rental property, and buy a new home. They might have received an inheritance that they want to invest.

All these life changes will influence their goals and their ability to invest towards them. Therefore, it's essential to stay flexible and ready to make changes as needed.

Seek assistance.

Obtaining professional guidance for your finances can be beneficial for many individuals. There are a variety of experts available to help, such as financial advisors, financial planners, investment advisors, lawyers, CPAs, and more. It is worth considering seeking their help during significant life events, or if you don't already have someone you regularly consult. Some of these instances include:

●     Getting married

●     Going through a divorce

●     Becoming a parent

●     Inheriting money

●     Starting or selling a business

Another indication that you need professional direction is if you feel uncertain or uncomfortable making investment decisions or if you and your partner disagree on strategy. In this case, a neutral third party, especially one with a fiduciary responsibility, can help resolve any disagreements and develop a plan that works for both of you.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Are There New 1031 Exchange Regulations in 2022?

Investors have questions about the future of 1031 exchanges every year. Politicians have long disagreed about the option to use a 1031 exchange to postpone capital gains. The answer to the question of whether this real estate investing tool has recently undergone alterations is no. Instead, investors all around the country are becoming more interested in 1031 exchanges, and new queries have arisen. The most frequent queries from today's curious investors are shown below.

What occurs when a property used in a 1031 exchange is sold?

An investor can transfer one investment property (the "relinquished property") for another (the "replacement property") through a 1031 exchange while deferring the capital gains taxes they would have to pay at the time of sale of the "relinquished property." The Internal Revenue Service (IRS) asserts that the two properties must be of "like-kind," which is defined as any property held for trade, business, or investment purposes under Section 1031 of the Internal Revenue Code.

Unrealized capital gains explained

Unrealized capital gains are gains achieved on an asset that hasn't yet been sold, according to investors and real estate experts. Unrealized capital gains are not subject to tax. In contrast, these gains only exist on paper. Taxes on capital gains are only due when an investor sells the asset.

1031-exchanges-Florida-real-estate-investing-retirement-planning-financial-services-registered-investment-advisors-FL

When can a real estate investor use a 1031 exchange?

Anytime properties are swapped, a 1031 exchange may be employed as long as the new properties are of like-kind according to the IRS. Commercial assets, such as apartment buildings, hotels, and motels, retail assets and single-tenant retail properties, offices and industrial complexes, farms and ranches, and undeveloped land are examples of properties that are frequently traded in a 1031 exchange. Investments in Delaware Statutory Trusts (DSTs) and residential properties held for investment reasons are additional transactions that qualify as like-kind exchanges.

Can a shareholder avoid capital gains by purchasing a second home?

Property owners frequently inquire about their ability to use a 1031 exchange to sell one home and buy another. Sadly, the response is no. Primary residences and second houses are not eligible for a 1031 exchange, according to the IRS; only residential properties held for investment purposes for at least a year are.

Can a shareholder withdraw money from a 1031 exchange?

The entire worth of the property that was given up, including any investor ownership and debt owed on the asset, must be replaced in order for capital gains to be postponed. As a result, if an investor sells a $1 million asset that is 50% leveraged, the investor will need to buy a $1 million replacement property and either use personal funds or leverage a loan for the remaining $500,000 in the transaction. Any money withdrawn from the transaction is subject to taxes.

But there are exceptions to every rule. Investing in a DST is one exception. A legally accepted real estate investment trust that enables investors to purchase fractional ownership interests is known as a Delaware Statutory Trust. Investors can choose how much money to put into a DST and how much debt they want the DST sponsor to attach to them when trading into a DST. A property owner could profit financially from this investment by selling the property.

How do 1031 exchanges operate?

Investors are obligated to adhere to the IRS's stringent timeframe for a 1031 exchange. Taxes are typically required on the property that has been given up when a 1031 deadline is missed.

When the sold property closes, a 1031 exchange's time frame begins. The owner of the property has 180 days to close and 45 days to find replacement properties. One of three requirements outlined by the IRS must be met by the replacement properties.

Do I require a third party to complete a Section 1031 exchange?

Yes! The involvement of a qualified intermediary (QI) or exchange facilitator is required by the IRS for 1031 exchanges. All revenues from the sale of the property that was given up are held by the QI, who will disburse them towards the purchase of replacement homes. The sale will not be eligible for a 1031 exchange if funds are retained with the seller or any other person that is not a QI, and the seller will be liable for paying capital gains if this occurs.

How does a 1031 exchange operate when there is seller financing?

Although it is legal to employ seller financing in a 1031 exchange, it is not frequently done.

However, this does not exclude them from IRC section 1031, which specifies that an investor must replace the total value of the relinquished property. Seller financing limits the immediate capital available to an exchanger. As a result, while extending seller financing, an investor must specify how they plan to buy their replacement homes. The easiest fix is to provide short-term funding.

However, most buyers' issues are not resolved by this. Instead, to raise the money for the exchange, the exchanger can cooperate with a qualified intermediary (QI) to sell the promissory note they obtained from the buyer. The note can be bought by the exchanger or sold to the lender or another party. Regardless of the choice made, all money must be transferred to the QI by the end of the 180-day period in order to keep the proceeds from being taxable. When money is available, the investor can exchange it for a specific like-kind property.

Can an investor still submit a 1031 exchange after a property closing?

No, since every penny from the sale of the property must be deposited with a QI, a seller cannot submit a 1031 exchange after the closing. Therefore, the proceeds cannot be allocated effectively for a 1031 exchange if the exchange is not preplanned. Before selling their property, investors interested in a 1031 exchange should choose a QI.

If investors reinvest, may they avoid paying capital gains tax?

Property owners can postpone capital gains through a 1031 exchange as long as they reinvest according to the IRS's guidelines. Reinvestment enables investors to take advantage of the many advantages a 1031 exchange has to offer, including portfolio diversification and capital gains deferral. Reinvestment through a 1031 exchange also resets the investment's depreciation schedule, giving owners access to further tax benefits.

IRS-tax-code-United-States-Florida-real-estate-investors-financial-planning-services-retirement-savings-tax-deferrals-1031-exchange-DSTs-REITs

What are the most popular real estate investment markets for 2022?

Depending on an investor's investment plan, they might choose the hottest real estate markets. Are they risk-averse and primarily interested in stable assets on primary markets? A value-add asset, a secondary market, or a tertiary market are some other options if they are willing to take on some risk in exchange for larger profits.

Contact a skilled 1031 exchange consultant to better understand which asset and market are appropriate for you. The Perch Wealth team can help you through the process and connect you to properties that are 1031 qualified and fit with your financial and investing goals.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

BD vs. RIA: Who to Consider for a 1031 Exchange

Investors looking to speak with a qualified professional about their 1031 exchange investment options can opt to work with a broker-dealer (BD) or registered investment advisor (RIA). While both BDs and RIAs can typically offer similar services, the scope of their expertise and fees can vary drastically. In this article, we define the difference between a BD and an RIA in the hopes of helping you determine which professional is a better fit for you.

What’s the difference?

RIAs are individuals or firms that typically focus on offering general financial advice, managing clients’ accounts, and executing stock trades for clients. RIAs generally charge an annual fee equal to a percentage of the assets they manage on behalf of their clients. 

BDs, on the other hand, primarily work to facilitate investment transactions for their clients. Fees are generally commission-based, meaning BDs typically charge a one-time fee for each transaction they facilitate rather than an ongoing fee.

The Relevance of a 1031 Exchange

Investors looking to sell their real estate and trade into a like-kind alternative investment should work with a qualified professional – either a broker-dealer or a registered investment advisor.

Today, one of the most common examples of a 1031 exchange is trading from a real estate property into a Delaware Statutory Trust (“DST”).

A DST “is a legally recognized real estate investment trust in which investors can purchase ownership interest. Investors who own fractional ownership are known as beneficiaries of the trust – they are considered passive investors. … Properties held in DSTs that are considered ‘like-kind’ include retail assets, multifamily properties, self-storage facilities, medical offices, and other types of commercial real estate.”

Miami-commercial-real-estate-investing-1031-exchange-FL-retiriement-planning-capital-gains-tax-deferment

These one-time transactions enable investors to sell their real estate and buy into a qualified investment while deferring capital gains. Furthermore, by trading into a DST, investors can access institutional quality assets they otherwise may not be able to purchase, leverage excellent financing obtained by a DST sponsor, access passive income potential that is management free, and limit their liability in the investment.

To better understand how trading into a DST works, it’s best to compare a DST to a real estate exchange rather than an equity purchase – there is a significant difference between the two when determining how much an investor should pay in fees.

Avoiding Potentially False Claims

Why is this important when deciding who to work with – an RIA or BD?

Today, many claims are often presented in an effort to win business from investors in a 1031 exchange or from those looking to place cash into a DST. Many RIAs claim it is cheaper to work with them than a BD because their commissions are waived. However, this claim ignores the fact that RIAs typically charge clients an ongoing annual fee. This fee has the potential to cost you more over time. It’s important to do your research to find out what the ongoing fee is, as well as what, if any, additional services you are receiving for that fee. Of note is the fact that the ongoing fee is typically calculated as a percentage of the value of the assets. That means that if the asset appreciates, you will be paying more, and if the asset depreciates, you'll be paying less.  As a result, it isn't possible to determine the exact cost of the advisory fee over time.

Let’s look at an example.

Say that an investor trades out of a retail property into a DST, an investment that will generally last for five to ten years before the investment is sold and the investor can do another exchange. Assume the investor puts $1 million into the DST. Now, let’s look at how much a BD would cost versus an RIA. If the BD charges a 6% commission on the investment, that results in a commission of $60,000 on the transaction. An RIA, on the other hand, charges a percentage of the assets under management (AUM) – in this scenario, the AUM is $1 million. Now, let’s say the RIA fee is 1.5% of the Assets Under Management (“AUM”). An investor would then pay $15,000 per year to the RIA for the investment (assuming the asset value remains stable). Based on the average holding period of a DST (five to ten years), the investor would pay between $75,000 and $150,000 for the exchange! Of course, in the event the DST sponsor exits early, or you are presented with an opportunity to liquidate/exchange early, that could result in a potentially lower fee.

investment-banking-real-estate-investors-finanical-assets-Florida-broker-dealer-registered-investment-advisors

Broker-Dealers May Cost Less than Registered Investment Advisors

The above model simply shows the cost difference between working with a BD and an RIA and outlines how working with a BD may be less expensive than working with an RIA. In the above scenario, the investor pays 50% to 250% more to work with an RIA than a BD. Imagine if an investor had millions to invest.

Don’t Pay Annual Fees on Passive Investments like DSTs and Other 1031 Exchange Investment Options

DSTs and other 1031 exchange investment options are set up as management-free investments, meaning no management responsibility is required of the investor or the one representing the investor in the transaction. Instead, sponsors manage these alternative investments on behalf of their investors completely; therefore, they are entirely passive. Why pay an RIA to “manage” your DST investment when it is already being managed for you?

Understanding the Options in a 1031 Exchange

Before jumping into any investment, an investor should conduct due diligence to fully understand the available options and associated fees. If an investor is choosing between an RIA and a BD, they should ask themselves who has more knowledge about the investment and whose fees align with the type of investment they are considering. These questions may help investors protect themselves and their capital in future investments. 

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

How Real Estate Investing May Shield You From Inflation

The term "inflation," which refers to the slow increase in the cost of products and services over time, has recently appeared in the headlines of all of the main business news outlets. Everyone was only interested in discussing how dramatically and finally the U.S.'s historically low inflation rate was coming to an end. Used car prices were breaking records, timber costs were skyrocketing, petrol prices appeared to be moving up, and food prices were higher than they had ever been.

Although the precise reason for price increases is still up for debate, it is no longer a secret that the cost of necessities like food and shelter is growing. Inflation is presently influencing the life and job of the typical American, and, while it stays genuine that we have encountered a lucky and broadened time of low inflation, it seems like all beneficial things do, as a matter of fact, reach a conclusion - - and presently is essentially the finish of inflation 's record lows.

The ramifications of high, or rising, inflation costs for financial backers is that high inflation can influence the worth of a future stream of income. Consequently, financial backers need to accomplish returns that are higher than the pace of price inflation. This implies that now, like never before, financial backers ought to get ready to change their venture techniques pushing ahead and carefully plan to support against inflation.

In this article, we'll define inflation, examine how it tends to be a headwind for financial backers, and foster one center thought: that land money management is possibly the support expected to safeguard yourself from inflation, as well as the deficiency of buying influence that outcomes from it.

What is inflation?

what-is-inflation-USD-real-estate-investors-1031-exchanges-Florida-Miami-FL

inflation is the slow inflation in the cost of labor and products after some time. It is estimated by observing changes in the Consumer Price Index, which is based on a record of normally bought goods and services. The U.S. Central bank is liable for setting financial approach, and inflation is quite often one of its essential worries.

The Federal Reserve for the most part attempts to oversee inflation to a specific objective (around 2-3% every year), however it saves the capacity to go to activity when price inflation lengths above or underneath this reach.

The most recent report from the U.S. Department of Labor Statistics shows that the Consumer Price Index (CPI), which is one proportion of inflation, has increased 5% throughout the last year alone. That is the most noteworthy increment beginning around 2008, which was, uncoincidentally, the last time the nation was in a monetary emergency.

How could inflation be a headwind for financial backers?

Inflation can be harming to financial backers' capital since they need to accomplish returns that are higher than the pace of economic inflation.

A model can be utilized to all the more powerfully come to this meaningful conclusion.

On the off chance that inflation is running at a pace of 3% yearly, and a financial backer keeps her capital in a currency market account that pays a proper pace of revenue at 2% yearly, she is really losing 1% of her buying power every year - - comparative with inflation. Over the long haul, the financial backer's capital can buy less on the grounds that the expense of labor and products has risen quicker than her speculation returns.

To stay away from a circumstance like this, financial backers ought to consider searching out inflation fences or resource classes that are exceptionally situated with the possibility to perform well in times of high economic inflation.

Real estate-centered financial planning may be the hedge you really want to shield yourself from inflation.

For what reason is real estate viewed as a decent hedge against inflation?

There are various reasons. As far as one might be concerned, one could analyze the impact of inflation on obligation. As a home's cost ascends after some time, it brings the credit down to worth of any home loan obligation, going about as a sort of regular markdown. Thus, the value on the property increments, yet your fixed-rate contract installments continue as before.

Inflation can likewise possibly help land financial backers who procure pay from investment properties, explicitly property areas with momentary rent structures, as multifamily lodging networks, on the grounds that higher home costs frequently compare to higher lease structures. In the event that a land financial backer can change her/his lease up while keeping the home loan something similar, this sets out the freedom for expanded cash in the financial backer's pocket.

At last, land might possibly be a decent support against inflation since property estimations after some time will generally stay on a consistent vertical bend. The vast majority of the homes that hit absolute bottom when the land bubble burst in 2008 returned to their pre-crash costs in under a solitary 10 years. Land speculations can likewise turn out expected repeating revenue for financial backers and can keep speed or even surpass inflation with regards to appreciation.

Since the proof gives off an impression of being supportive of land, and it being a resource class that has generally held its own when confronted with increasing inflation rates, we should now direct our concentration toward a couple of procedures commonly used to endeavor to fence land ventures against inflation.

How might you possibly involve real estate as a hedge?

Potentially one of the most mind-blowing ways of utilizing land to support against inflation is to put resources into a multifamily property. Different kinds of properties, like business structures (like retail locations), have their inhabitants sign long term business leases. Multifamily lodging for the most part recharge rents exclusively with each occupant one time per year. The more units a structure has, the more regularly you're given sufficient chances to change the lease. The equivalent is valid for self-capacity.

What's more, multifamily properties, for example, apartment buildings are a one of a kind resource class in that they are commonly consistently popular, particularly while lodging costs take off. Furthermore, because of late inflations in labor and material expenses, there is a restricted stock of structures or new improvement projects, which can make an ascent in rental rates and property estimations. Together, these two elements equivalent a property that can possibly not be empty for significant stretches of time and various openings to restore or begin leases at market-changed rates.

Another thing to consider is that cost repayments, another rent part, is an extra way land money management can possibly pace inflation. Leases pass some type of a property's ongoing working costs down to their occupants, no matter what the kind of building structure. As utility and support costs ascend because of inflation, landowners or building proprietors can be undoubtedly somewhat protected from the impacts on the property's income.

It is clear, then, at that point, that real estate investing - - especially putting resources into multifamily lodging properties - - might possibly be a decent fence against inflation that our ongoing business sector brings to the table. Land effective money management is in many cases thought about a way towards reserve funds safeguarding in an inflationary and capricious economy.

It's very simple to see the reason why financial backers have rushed to real estate in the midst of monetary vulnerability. No matter what, lodging will continuously be required, and hence, probable sought after. A speculation property that is bought and clutched for the long haul can possibly be a safe method for developing the first interest into something more significant not too far off.

1031-exchanges-Floriida-real-estate-investment-properties-capital-gains-tax-deferral

On the other hand, in the event that financial backers can't - - or just don't have any desire to - own and deal with the venture property themselves, they can consider land trusts (REITs), intuitional land assets, and Delaware Statutory Trusts (DSTs). How one chooses to go about land money management is completely dependent upon them; it is, and ought to be, an individual monetary choice. In any case, it very well may merit your time and energy to educate yourself pretty much all regarding your choices and survey from that point - - or talk with a learning experience master like the group at Perch Wealth.

Why putting resources into a DST can be an alluring choice

In the event that your main concern is to look for abundance safeguarding during an inflationary financial period, then, at that point, putting resources into a Delaware Statutory Trust, or DST, is possibly a very appealing land venture choice. A DST is an ordinarily involved structure for those looking to partially put resources into land.

A DST is a way for financial backers to possess land with the chance of procuring recurring, automated revenue and zero administration obligation. Most financial backers don't commonly consider whether they are keen on dynamic versus aloof responsibility for domain property, and thusly, get into circumstances that they believe they aren't equipped for, intrigued by, or profiting from in the ways that they might want to be. For a first-time frame or moderately new financial backer, putting resources into a DST is an incredible prologue to a possibly recurring source of income and collection of uninvolved riches.

There are two essential ways that an individual can put resources into a DST. The first is through an immediate money speculation. For instance, perhaps you're new to land effective money management and just need to secure your opportunity; you could hope to put $50,000 in a DST to acquire a traction in the land business. The second is by using a 1031 Exchange.

Numerous financial backers are really ignorant that they can use a 1031 Exchange to put resources into a DST, however there are numerous potential advantages to doing as such. By doing a 1031 Exchange, you can probably expand the ongoing level of the housing market and differentiate your assets into various DSTs that are geologically shifted and in particular resource classes, assisting with moderating and conceivably limit the general gamble to your capital. Assuming that you're keen on finding out about 1031 Exchanges, DSTs, or more elective land speculation systems, you can talk with one of Perch Wealth's financial experts today.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure: