Investors sometimes inquire, "What happens to my 1031 Exchange transaction if I sell my relinquished property and cannot find suitable like-kind replacement property to identify, or if I cannot acquire the property that I did identify within the prescribed 180 days' regulations?"

A 1031 exchange with an installment sale allows a seller to defer paying capital gains taxes on the recognition of gain from the sale of an investment property by exchanging the property for a similar investment property and receiving an installment sale note as part of the exchange proceeds. 

However, if the seller cannot acquire the replacement property or properties within the required time frame, the exchange may fail. In this case, the seller may still be able to structure the sale as an installment sale and defer paying taxes on the gain from the sale until the installment sale note is paid off.

Structuring a Failed 1031 Exchange into an Installment Sale 

To structure a failed 1031 exchange into an installment sale, the seller must follow specific steps:

The seller sells their investment property and receives the proceeds, which may include an installment sale note. The seller must work with a qualified intermediary (QI) to handle the exchange.

The seller identifies replacement property or properties within 45 days of the relinquished property's sale, but cannot acquire the replacement property or properties within the 180-day time frame required for a 1031 exchange. This means that the exchange has failed.

The seller elects to treat the sale as an installment sale, meaning they will defer paying taxes on the gain from the sale until the installment sale note is paid off. The seller must make this election on their tax return for the year of the sale.

The seller and the buyer negotiate the terms of the installment sale note, including the interest rate and payment schedule. The note must be secured by a mortgage or deed of trust on real property and must be payable over at least two tax years at a market rate of interest.

The seller assigns the installment sale note to the QI to hold until the note is exchanged for a similar investment property. The QI will hold the note in a separate account until it is exchanged for a similar investment property. The note must meet certain requirements to be eligible for a 1031 exchange, including being secured by real property and payable over a period of at least two years at a market rate of interest (reference IRS form 6252 and IRS form 8824 for tax straddling).

The seller uses the proceeds from the sale to acquire other investments or assets, and defers paying taxes on the gain from the sale until the installment sale note is paid off. The seller must report any interest income on the installment sale note as it is received.

If the seller later acquires replacement property or properties that meet the requirements for a 1031 exchange, they may be able to exchange the installment sale note for the replacement property or properties, and continue to defer paying taxes on the gain from the sale of the relinquished property.

It's important to work with a qualified intermediary and a tax professional when structuring a failed 1031 exchange into an installment sale to ensure compliance with the rules and requirements of the exchange, and to understand the tax consequences of the sale. If the seller has already reported the sale as a failed exchange on their tax return for the year of the sale, they may need to file an amended return to report the sale as an installment sale or they become a taxpayer.

Pros of Structuring a Failed 1031 Exchange into an Installment Sale 

Structuring a failed 1031 exchange into an installment sale can have some advantages for the seller, including:

Deferring taxes: By structuring the sale as an installment sale, the seller can defer paying taxes on the gain from the sale until the installment sale note is paid off. This deferral can provide the seller with more cash flow in the short term, and may allow them to reinvest the proceeds from the sale into other investments or assets without having to pay taxes on the gain.

Flexibility: The seller has more flexibility in how they use the proceeds from the sale, since they are not required to use the proceeds to acquire replacement property within the 180-day time frame required for a 1031 exchange. This can allow the seller to take advantage of other investment opportunities or to use the funds for other purposes.

Potential for a future exchange: If the seller later acquires replacement property that meets the requirements for a 1031 exchange, they may be able to exchange the installment sale note for the replacement property and continue to defer paying taxes on the gain from the sale of the relinquished property.

Reduced risk of losing the sale: If the seller is unable to acquire replacement property within the required time frame for a 1031 exchange, they risk losing the sale and being unable to defer paying taxes on the gain from the sale. Structuring the sale as an installment sale can reduce this risk, since the seller is not required to acquire replacement property within a specific time frame.

It's important to note that structuring a failed 1031 exchange into an installment sale does not eliminate the tax liability on the gain from the sale, but rather defers the taxes until the installment sale note is paid off. 

Cons of Structuring a Failed 1031 Exchange into an Installment Sale 

While structuring a failed 1031 exchange into an installment sale can have some advantages for the seller, there are also some potential drawbacks to consider, including:

Interest income: The seller will receive interest income on the installment sale note as it is paid off, and will owe taxes on that income in the year that it is received. This may reduce the benefit of deferring taxes on the gain from the sale, particularly if the interest rate on the note is high.

Risk of default: If the buyer defaults on the installment sale note, the seller may lose the opportunity to defer paying taxes on the gain from the sale. While the note must be secured by real property, there is still a risk of default, particularly if the buyer experiences financial difficulties.

Risk of audit: Structuring a failed 1031 exchange into an installment sale can be complex, and the IRS may closely scrutinize the transaction to ensure that it meets the requirements for a 1031 exchange and an installment sale. If the transaction is found to be noncompliant, the seller may owe taxes on the gain from the sale, as well as penalties and interest.

Limited reinvestment options: By deferring taxes on the gain from the sale, the seller may be limited in their ability to reinvest the proceeds from the sale, since they cannot use the funds to purchase non-like-kind assets without incurring taxes.

Loss of potential tax benefits: By structuring the sale as an installment sale, the seller may lose the potential tax benefits of a 1031 exchange, such as the ability to defer paying taxes on the gain from the sale indefinitely if they continue to exchange into like-kind properties.

It's important to weigh the potential benefits and drawbacks of structuring a failed 1031 exchange into an installment sale, and to work with a qualified intermediary and a tax professional to ensure compliance with the rules and requirements of the exchange, and to understand the tax consequences of the sale. 

Sera Capital helps clients by acting as a fee-only fiduciary focusing on tax-efficient exit planning. We offer DST 1031 exchange services through special situations where investors could put 1031 real estate into a securitized property while deferring taxes. 

If you have a failed 1031 exchange and you'd like to know more about installment sales and your other investment options, schedule your free 30-minute call today.

An installation sale can help investors who own properties with impressive appreciation sell properties without fear of incurring large capital gains tax liability. So, what qualifies properties for installment sales? Read through this brief overview of installment sales, their qualifications, and benefits.

What Is an Installment Sale?

An installment sale consists of several revenue recognition approaches under the Generally Accepted Accounting Principles (GAAP). Installment sales account for when expenses and revenue become recognized at cash collection instead of at the time of purchase. It’s a principal method of revenue recognition occurring during a sale.

Qualifications and Requirements

Installment sales can help sellers maintain their income within a preferred tax bracket by spreading out their income. The installment sales can also maintain capital gains tax in a lower tax bracket. Furthermore, installment sales can avoid higher or lower net investment income taxes, higher premiums, and alternative minimum taxes. So, what qualifies a property for installment sales?

Two requirements qualify for an installment sale. First, if an asset becomes sold and payments get made over time, at least one payment must occur after the sale’s tax year. The second method of an installment sale is recorded on Form 6252. Installment sales aren’t available with properties or assets sold at a loss or if real estate or personal properties are sold through dealers. Lastly, selling investment securities and stocks doesn’t qualify for installment sales.

Benefits of Installment Sales

Installment plans are effective tools that aid sellers who want to maintain lower income tax to defer capital gains tax. Explore some beneficial qualities of installment plans and what they can offer buyers and sellers. Some benefits include lower tax brackets, investment safety, little to no capital gains tax, lower market interest rates, and more.

Investment Safety

Installment sales are seller financing models where original owners sell properties but don’t collect payments in one swoop. It’s similar to buying a mortgage and paying for said property in one accumulated sum but getting the mortgage from the seller instead. As a result, it’s a relatively secure income stream for the seller, as the property remains as collateral.

If the buyer rescinds their agreement to pay for the property or has no stable financial footing, sellers can take the property back, similar to a bank. Buyers also have greater safety; the property goes into foreclosure if they can’t pay a bank-backed mortgage. In many cases, there’s little recourse to negotiate better terms that permit them to keep the property. Installment plans can potentially allow buyers to renegotiate the terms of the sale with the seller, such as agreeing to pay more over time with fewer monthly payments.

Interest Rates Below Market

If buyers visit a bank or a different institutional lender to receive capital for purchasing a property, they receive an interest rate related to the overall real estate market. Even with interest rates sitting on the lower end for homebuyers, investors could have higher interest rates in loans due to the added risk. For instance, investors can easily walk away from properties if situations go negatively, especially if it isn’t their residence.

Furthermore, commercial investment loans can also receive an extension for a shorter period. Bridge or swing loans only provide capital until buyers can access more standard financing. Buyers can secure purchases at lower market interest rates when a seller-backed sale agrees to installation payments. It’s especially true for securing one below the high-interest rates of bridge and swing loans.

Lower Tax Brackets

A significant benefit to installment plans is that they can aid the buyer by placing themselves into a lower tax bracket. A sizable property or property with a sizable value sale, whether residential or commercial, can push investors into a tax bracket they’d prefer to avoid. Most investors see income changes from year to year—investors with fluctuating incomes can thus face tax rates meant for higher incomes.

Installment plans allow real estate investors to plan out their income accordingly so that they don’t face taxes that potentially pose a risk to their business in the future. Furthermore, lower tax brackets provide the benefit of saving money. Most real estate investors and business professionals utilize itemized deductions to decrease tax burdens and lower gross profits each taxable year.

Minimal to No Capital Gains Tax

Another benefit of installment sales is the limited capital gains tax. Capital gains tax is an intrusive tax that every investor wants to defer as much as possible for real estate investments. If investors have a deal exceeding $469,000, capital gains income taxation going rates reach upward of 20 percent.

It’s an incredibly staggering number—if an investor makes a million-dollar real estate sale, they must pay an estimated $200,000 in tax money. While there are instances where capital gains tax is beneficial, it’s a rare occurrence. Installment sale methods can aid investors in deferring unwieldy taxable gains. So, it’s no surprise that many investors use installment plans for real estate sales.

Top Price and Easy Sales

Both real estate sellers and buyers can benefit from seller financing. Sellers have more leverage to get the desired price due to buyers not requiring an upfront cash payment. Buyers can instead have an easier time closing real estate deals due to their direct approach to the seller and easily work out purchasing terms.

When selling property, getting the desired price can become a tricky endeavor. So, it’s common for asking prices to lower, so much so that sellers must factor it into their advertised selling price. For residential transactions, buyers will present the seller with one lump sum, reducing their ability to close the deal with the asking price they want. Sellers who finance the arrangement for the buyer via installation notes have more leverage to receive the price they asked for.

High-Interest Income

Because sellers and buyers agree to space out property payments over a set number of years, negotiation of interest rates and sale price can occur. It’s an ideal opportunity for sellers to obtain a steady income stream with locked-in interest rates, a beneficial anchor for their investment portfolio. It’s especially helpful if sellers place cash in fluctuating value investments.

For instance, real estate developers could sell off developed pieces, creating a steady income stream and providing consistent revenue over a longer period. Monetized sales installments can help sellers collect the accumulated interest payments that would’ve ended up in the possession of traditional lenders or banks. Adversely, buyers can write off the interest they pay as part of their installment plan obligations.

Sera Capital offers its expertise and knowledge to individuals who need a fee-only fiduciary. Our registered financial advisors provide investors with the tools to handle 721 and 1031 exchanges, Delaware Statutory Trusts, and other investment types. For more information, schedule a free 30-minute phone call today.

What Qualifies a Property for an Installment Sale?

The Role Of Debt Financing In 721 Exchange Properties: Pros And Cons

An Internal Revenue Code Section 721 exchange is a type of transaction where a partnership or other entity can contribute appreciated property to a real estate investment trust (REIT) in exchange for operating partnership units (think REIT shares) of the REIT without triggering a taxable event. Debt financing can be used in conjunction with a 721 exchange to finance the acquisition of the replacement assets.

Here are some potential advantages and disadvantages of using debt financing in a 721 exchange:

Advantages Of Using Debt Financing In A 721 Exchange UPREIT

Increased purchasing power

By using debt financing, the partnership or entity can increase its purchasing power and acquire properties that they might not be able to afford with all-cash financing. This can allow them to take advantage of investment opportunities and portfolios that might not otherwise be available.

Leveraged returns

Debt financing can potentially increase the returns on the contributed properties if the properties generate a higher rate of return than the interest rate on the debt (as of the time of this publication, debt is still dilutive, not accretive).

Tax benefits

The interest paid on the debt can be deducted from the partnership or entity's taxable income, reducing their overall tax liability.

Depreciation

If your basis is zero, you get to depreciate the additional debt.

Reduced equity requirements

By using debt financing, the partnership or entity can reduce the amount of equity required to acquire the replacement properties, which can free up capital for other investments or uses.

Diversification

Debt financing can enable the partnership or entity to diversify their real estate holdings by acquiring a mix of properties or portfolio with different characteristics and income streams.

Disadvantages Of Using Debt Financing In A 721 Exchange

Here are some potential disadvantages or risks of using debt financing in a 721 exchange:

Increased risk of default

By taking on debt to finance the acquisition of contributed properties, the partnership or entity is taking on additional financial risk. If the properties do not generate sufficient income to cover the debt payments, the partnership or entity may be unable to meet their financial obligations and could default on the debt.

Interest rate risk

Debt financing exposes the partnership or entity to the risk of rising interest rates. If interest rates increase, the cost of servicing the debt will increase, potentially reducing the overall profitability of the investment.

Higher costs and fees

Debt financing can come with higher costs and fees compared to all-cash financing, including origination fees, appraisal fees, and other closing costs.

Reduced cash flow

Debt payments can reduce the cash flow generated by the contributed properties, which can limit the partnership or entity's ability to reinvest in the properties or make distributions to investors.

Limited flexibility

Debt financing can limit the partnership or entity's flexibility in managing the contributed properties, as they must generate sufficient income to cover the debt payments and meet other financial obligations.

Final Thoughts

It's worth noting that debt financing also comes with potential risks and downsides, such as the risk of default, the risk of rising interest rates, and the potential for higher costs and fees associated with the financing. As with any investment decision, it's important to carefully consider the pros and cons of debt financing in a 721 exchange and consult with a qualified financial advisor or tax professional before making any investment decisions.

If you're entering a 1031 exchange and have debt to replace, it's important that your Delaware Statutory Trust property carries non-recourse debt or that you cover your debt replacement in some other way. Otherwise, you will be paying capital gains tax on that debt boot.

Fortunately, there are a number of ways to cover your debt requirement so that when you exit your 1031 property with debt, you're able to purchase a 721 DST and satisfy your debt requirement before transitioning to the REIT. For example, one 721 DST Sponsor will lend up to your equity contribution. That's just one method. There are a handful of other ways.

Thinking of doing a 1031 Exchange, DST, or 721 Exchange? Sera Capital helps clients by acting as a fee-only fiduciary focusing on tax-efficient exit planning. We offer DST 1031 exchange services through special situations where investors could put 1031 real estate into a securitized property while deferring taxes.

Schedule a free 30-minute call today.

Installment sale (IRS Section 453 - including both Structured Installment Sales and Deferred Sales Trusts) taxation refers to the tax treatment of an installment sale, which is a type of sale in which the buyer pays the seller over time rather than paying the full purchase price upfront in the current tax year. This is not a new concept by any consideration. The tax treatment of an installment sale differs from that of a regular sale because the seller only recognizes income as payments are received over time. This allows for efficient tax planning and the possibility of savings through deferral at lower tax rates as you elect out of paying the full taxes on your assets upfront.

Under the installment sale method, the seller only recognizes income on the portion of the sale price received each year rather than recognizing all of the income in the year of the sale. The seller's gain on the sale is determined by the gross profit percentage, which is the gross profit on the sale (i.e., the sale price minus the seller's basis in the property) divided by the total contract price. The seller's basis in the property is reduced each year by the portion of the sale price allocated to principal payments.

The tax treatment of an installment sale can be complex, and it's important for you to consult with a tax professional for specific guidance on your situation. However, the installment sale method generally can benefit sellers who want to defer their tax liability on the sale because they only recognize income as payments are received.

Below are some of the basic guidelines when it comes to installment sale tax treatment. 

Eligible income recognition

Under the installment sale method, the seller only recognizes income as payments are received over time. This means that the seller does not recognize all of the income from the sale in the year of the sale but instead recognizes a portion of the ordinary income each year as payments are received. The portion of the income that is recognized each year is based on the gross profit percentage.

Gross profit percentage

The gross profit percentage determines the portion of each payment that represents income. The gross profit percentage is calculated by dividing the gross profit on the sale (i.e., the sale price minus the seller's basis in the property) by the total contract price. The gross profit percentage represents the portion of the sale that is profit for the seller and is used to allocate the gain over the life of the installment sale.

Basis adjustments

The seller's basis in the property is reduced by the portion of the sale price allocated to principal payments each year. This means that the seller's gain on the sale will increase over time as the basis of the property is reduced. The basis adjustments reflect that the seller receives payments over time rather than all at once and therefore needs to adjust their basis in the property over time.

Interest income

If the seller charges interest on the installment sale, the interest income is recognized as earned each year. Interest income is considered separate from the sale price and is recognized as income in the year earned. The interest income is calculated based on the interest rate charged on the installment sale and the outstanding balance each year.

Reporting

The seller must report the installment sale on Form 6252, which is attached to their tax return for the year of the sale. The form includes information about the sale price, the gross profit percentage, and the payments received each year. The seller must also report any interest income earned on the installment sale on their tax return for each year.

Final Thoughts

In summary, the tax treatment of an installment sale is unique because the seller only recognizes income as payments are received over time. This means that the seller must use the gross profit percentage to allocate the profit over the life of the installment sale and must adjust their basis in the property each year to reflect the principal payments received. 

Interest income earned on the installment sale is also recognized separately from the sale price and must be reported annually. It's important to consult with a tax professional for specific guidance on your situation, as the tax treatment of an installment sale can be complex and may vary depending on the circumstances of the sale.

Are you considering doing a 1031 Exchange, DST, or Installment Sale? Sera Capital helps clients by acting as a fee-only fiduciary focusing on tax-efficient exit planning. We offer DST 1031 exchange services through special situations where investors could put 1031 real estate into a securitized property while deferring capital gains taxes. 

Schedule your free 30-minute call today.

Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.” 

A structured installment sale, also known as a seller-financed sale or a seller carryback, is a type of financing arrangement where the seller of a property or business (or both) agrees to receive payment in installments over time instead of receiving the full amount upfront. In a structured installment sale, the buyer typically makes a down payment and then pays the seller in regular installment payments over months or years, with interest. 

The terms of a structured installment sale can be negotiated between the buyer and seller and can include factors such as the purchase price, the interest rate, the length of the payment term, and the down payment amount. The seller may also retain some ownership interest in the property or business until the final payment is made, acting as collateral for the seller. We see this often.

When businesses and partnerships want to liquidate their holdings and benefit from tax deferral, the structured installment sale can be an excellent way to defer taxation. When you examine the history of tax deferrals, you'll find that they are primarily sold in the form of a guaranteed annuity through a big insurance company. Rather than receiving the funds directly, the funds go to a qualified assignment company which then pays the client a stream of income over a predetermined time agreed and an agreed upon purchase price. The significant advantage is that you can defer those payments for 10-20+ years with a structured installment sale. Another advantage is that you can receive the lump-sum that you receive and spread payments out over a lifetime.

While most of our articles speak to both the advantages and disadvantages, this one only speaks to the disadvantages. Keep reading to find out some of the disadvantages of structured installment sales. 

7 Disadvantages Of Structured Installment Sale

Here are some potential disadvantages or risks of doing a structured installment sale:

Risk of default

If the buyer cannot make the payments on the loan, the seller may be forced to foreclose on the property or business and take legal action to recover the outstanding balance. This can be a costly and time-consuming process that can result in the seller losing money.

Interest rate risk 

If interest rates rise during the payment term, the seller may be stuck with a lower interest rate than the current market rate, which could lead to lost income.

Liquidity risk

Structured installment sales can tie up a significant amount of capital, which could limit the seller's ability to invest in other opportunities or meet their financial obligations.

Market risk

The value of the property or business could decline during the payment term, which could result in the seller receiving less money than they would have with an all-cash sale.

Refinancing risk

Suppose the buyer cannot obtain traditional financing to refinance the loan when it comes due. In that case, the seller may be forced to extend the payment term or foreclose on the property or business.

Administrative burden

Structured installment sales require the seller to manage the loan and collect payments, which can be a time-consuming and administrative burden.

Legal and tax implications

Structured installment sales can be complex and involve legal and tax implications, such as the need to comply with state and federal lending laws and the potential for tax consequences.

Final Thoughts

It's important to carefully consider these risks and downsides of using a structured installment sale and work with a financial advisor or attorney to determine whether it is the right choice for your situation. Other factors to consider might include the creditworthiness of the buyer, the overall market conditions, and the potential for interest rate fluctuations over time, among others.

Thinking of doing a 1031 Exchange, DST, or Structured Installment Sale? Sera Capital helps clients by acting as a fee-only fiduciary focusing on tax-efficient exit planning. We offer DST 1031 exchange services through special situations where investors could put 1031 real estate into a securitized property while deferring potentially large capital gains taxes. While 1031s make sense for real estate, structured installment sales usually work better with businesses or goodwill.

Schedule your free 30-minute call today.

If you're looking to sell real estate and defer capital gains taxes, there are many strategies that you can use. This strategy, in particular, allows you to close on a new property in the form of a Delaware Statutory Trust that will then be absorbed by a major REIT. While a forward exchange into a DST then REIT can be an excellent tax deferral strategy, a reverse exchange into a REIT flips the concept on its head and makes sense for real estate investors who have the cash on the sidelines and are planning on listing, selling, and closing on their relinquished property in less than six months.

John wishes to carry out a tax-deferred exchange in accordance with Internal Revenue Code Section 1031. Several months ago, John discovered an investment property and signed a contract to purchase it. John has been actively selling five investment homes since that time, but has had little success in getting purchasers. The contract for the replacement property is about to expire, and the seller has informed John that it will not be extended.

John does not want to lose this replacement property, but he does want to conduct a tax-deferred exchange. To complete a reverse exchange, enter into a Qualified Exchange Accommodation Agreement (QEAA) in accordance with IRS Revenue Procedure 2000-37 (Rev. Proc. 2000-37).

Understanding Reverse Exchange Under Rev. Proc. 2000-37

Reverse exchanges are done under Rev. Proc. 2000-37 by "parking" either the replacement property or the relinquished property with a third party until the actual exchange of properties can take place. 

In the aforementioned scenario, John would seek out a third party ready to act as an Exchange Accommodation Titleholder (EAT) and assign the replacement property purchase contract to the EAT. The EAT would acquire title to the replacement property using cash given by John or a lender and would maintain title to the replacement property until John is able to sell one of the investment properties (relinquished property).

The contract for the sale of the relinquished property would be assigned to a Qualified Intermediary (QI), and title would be transferred to the QI, who would then transfer it to the buyer. The QI would then use the sale proceeds to acquire the replacement property from the EAT and transfer the replacement property to John to complete the exchange.

How Does the Safe Harbor Operate Under Rev. Proc. 2000-37

The IRS released Revenue Procedure 2000-37 to clear up some of the misunderstanding in this area, promote "sound tax administration," and offer taxpayers with a realistic method of completing reverse exchanges. This directive establishes a safe harbor for taxpayers who enter into "qualified exchange accommodation arrangements” (QEAAS) on or after September 15, 2000.

If the transaction is structured as a QEAA, the IRS will not question the qualification of property as replacement or surrendered property, nor will it contest the AT's status as the beneficial owner of the property under Revenue Procedure 2000-37. As a result, Revenue Procedure 2000-37 only applies to reverse swaps that qualify as QAEEs. A reverse exchange must meet six requirements to become a QAEE:

The property is held by an Exchange Accommodation Titleholder (EAT) - a person who is not the taxpayer or a disqualified person and who is subject to federal income tax. (If this person is a partnership or an S corporation 90% of partners or shareholders must be subject to federal income tax.)

The Taxpayer must have a bona fide intent that the property be held as either replacement property or relinquished property in a qualifying exchange when transferring it to the EAT.

A written agreement must be entered into within five business days after the transfer of the property to the EAT that provides that:

a) Property is held for the benefit of the Taxpayer in order to facilitate an exchange under 1031 and Rev. Proc. 2000-37; 

b) Taxpayer and EAT agree to report the acquisition, holding, and disposition of the property as provided in Rev. Proc. 2000-37; and 

c) EAT will be treated as the beneficial owner of the property for all federal income tax purposes.

No later than 45 days after the transfer of the replacement property to the EAT, relinquished property must be identified in a manner consistent with the principles for identifying replacement property found in 1.1031(k)-1(c)(4) of the Treasury Regulations.

No later than 180 days after the transfer of the property to the EAT, the property is transferred to the Taxpayer as replacement property or to a person other than the Taxpayer or a disqualified person as relinquished property.

The combined time period that the relinquished property and the replacement property are held does not exceed 180 days.

As a result of requirement four, John in the example must identify three potential relinquished properties within 45 days, or any number of potential relinquished properties as long as the aggregate fair market value of the identified relinquished properties does not exceed 200% of the value of the replacement property, or any number of potential relinquished properties regardless of their value, provided 95% of the identified relinquished properties. 

Reverse Exchange Into A REIT

One of the questions we get often at Sera Capital is that, can an individual do a 1031 exchange directly into a REIT? The technical answer which may surprise many investors is “NO” – at least not directly. As many of our clients already understand, funds in an Exchange can only be reinvested in “like-kind” properties. Shares in a company are not considered “like-kind” and therefore direct investments into a REIT or any other company’s shares are not permitted.

Exchange money, on the other hand, can be invested in properties constituted as a Delaware Statutory Trust (DST). Over time, some DST sponsors have developed a DST option that includes both DST and REIT structures. Investors in these offerings first invest in a DST, and then the Sponsor will offer or, in some situations, require that the DST's interests be acquired by an affiliated REIT through a tax-neutral procedure known as a 721 Exchange.

If this serial process is correctly followed, the outcome for the investor is that they eventually end up with all their exchange funds now being invested in REIT shares. However, while no taxes are due when DST funds are first converted into REIT shares, the investor will lose the ability to complete a future 1031 Exchange with those funds.

Thinking of doing a reverse exchange, or want to do a 1031 exchange into a REIT? At Sera Capital, we are open for business and stand ready to assist you with your exchange transaction.

If you need a personal exchange consultation, we are happy to schedule a FREE call at a time that works with your schedule and situation. 

When the correct combination of circumstances arises, there may be no easier way to defer or decrease long-term capital gains taxes when selling real estate, companies, or other valuable assets than a structured installment sale. Online searches for capital gains avoidance usually lead to a few common tactics, with the 1031 exchanges at the top of the list. Despite its history, structured installment sales (IRS Section 453) are rarely included in the same topic.

Structured installment sales, which are easier to implement than 1031 exchanges because there are no timing or like-kind requirements, allow a buyer to acquire a property, business, or certain other appreciated assets for cash, while the business seller can arrange for the sales proceeds to be distributed according to a planned schedule created to anticipate more favorable future income tax positions.

Unlike many other methods that primarily focus on tax deferral and, ultimately, elimination, a structured installment sale will not eliminate taxes on profits, even if the gain is considerable. Keep reading to discover the pros and cons of structured installment sales before deciding if it is the best option for your next tax deferral move.

Pros of Structured Installment Sales

Below are some of the advantages of structured installment sales:

Increased marketability

Offering seller financing can make a property or business more marketable, especially when buyers may need help to obtain traditional financing or where there is limited financing available.

Higher selling price

A structured installment sale can allow the seller to sell their properties or businesses for a higher price than they would have received with an all-cash sale. This is because the seller can charge interest on the loan and spread out the payments over a more extended period of time.

Diversified investment portfolio

The seller can diversify their investment portfolio and generate steady income installments by accepting payments over time.

Lower taxes

By spreading out the payments over time, the seller may reduce their tax liability, as they will only pay taxes on the portion of the sale they receive each year.

Flexibility

A structured installment sale can be structured to meet the needs of both the buyer and the seller. For example, the seller may negotiate a higher interest rate or a shorter payment term if they need the cash upfront. In comparison, the buyer may be able to negotiate a longer payment term or a lower interest rate if they need more time to pay off the loan.

Cons of Structured Installment Sales

While structured installment sales can have some potential benefits, there are also some potential downsides or cons to consider. Here are some of the most common cons of structured installment sales:

Risk of default

If the buyer cannot make the payments on the loan, the seller may be forced to foreclose on the property or business and take legal action to recover the outstanding balance. This can be costly and time-consuming, resulting in the seller losing money.

Interest rate risk

If interest rates rise during the payment term, the seller may be stuck with a lower interest rate than the current market rate, which could lead to lost income.

Liquidity risk

Structured installment sales can tie up a significant amount of capital, limiting the seller's ability to invest in other opportunities or meet their financial obligations.

Market risk

The value of the property or business could decline during the payment term, resulting in the seller receiving less money than they would have with an all-cash sale.

Legal and tax implications

Structured installment sales can be complex and involve legal and tax implications, such as the need to comply with state and federal lending laws and the potential for tax consequences.

It's important to consider these cons carefully and work with a financial advisor or attorney to determine whether a structured installment sale is the right choice for your situation.

Step Up in Basis

With a structured installment sale, you do not receive a step-up in basis upon death. You do pay the taxes as you receive the income.

A Worthwhile Approach

An installment sale is an approach worth exploring for anyone with high-value assets. It can play a key role in your estate plan and may help keep a family-owned company in the family.

Of course, this simple technique isn’t right for everyone. To determine whether an installment sale is the best path for you and your business — and to find out about other tax-smart options — please contact us at Sera Capital.

We would be happy to schedule a free 30-minute consultation to discuss your situation.

An IRS Section 1031 exchange is a tax deferred exchange of one investment property for another. When a property is sold in a 1031 exchange, the seller can defer paying capital gains taxes on the sale if they reinvest the proceeds in a similar property. This means that the seller can use the proceeds from the sale to acquire a replacement property or properties without paying taxes on the gain from the sale of the relinquished property.

If the seller receives an installment sale note (section 453) as part of the proceeds from the real estate transaction, they can include the note in the 1031 exchange. This means that the seller can defer paying taxes on the gain from the sale of the property until the note is paid off, as long as the note is exchanged for a similar investment property.

Here's how it works:

The seller sells their investment property and receives the proceeds from the sale, which may include an installment sale note. The seller must work with a qualified intermediary (QI) to handle the exchange.

The seller identifies the replacement property or properties within 45 days of the sale of the relinquished property. The seller must provide a written description of the replacement property or properties to the QI, who will hold the proceeds from the sale of the relinquished property in a separate account.

The seller assigns the installment sale note to the QI, who will hold the promissory note until it is exchanged for a similar investment property. The note must be secured by a mortgage or deed of trust on real property, and must be payable over a period of at least two years at a market rate of interest.

The QI uses the net cash proceeds from the sale of the relinquished property, including any proceeds from the installment sale note, to acquire the replacement property or properties. The note must be exchanged for a similar investment property, which means that the replacement property or properties must have a value equal to or greater than the value of the note.

The seller defers paying taxes on the gain from the sale of the relinquished property until the note is paid off. However, any gain on the note will be recognized in the year that the note is paid off, so the seller will owe taxes on that gain at that time.

The seller must comply with the other requirements of a 1031 exchange, including the 180-day time frame for acquiring replacement property or properties, and the rules regarding like-kind property.

Some additional things to keep in mind:

Including an installment sale note in a 1031 exchange can be a complex process that requires careful planning and compliance with the rules and requirements of the 1031 exchange process. It's important to work with a qualified intermediary and a tax professional to ensure compliance.

The seller must identify replacement property or properties within 45 days of the sale of the relinquished property and must acquire the replacement property or properties within 180 days after the sale. The QI will use the proceeds from the sale of the relinquished property, including any proceeds from the installment sale note, to acquire the replacement property or properties.

If the seller does not acquire a replacement property or properties that are equal to or greater in value than the installment sale note, the seller will owe taxes on the gain from the sale of the relinquished property.

There are ways that you can circumvent paying taxes on the "boot." You can either:

A: Add funds to the exchange (not always ideal, but still doable for some)

B: Purchase a zero coupon DST (cheap way to purchase debt)

C: Consider a qualified opportunity zone fund

D: Include a deferred sales trust as part of your exchange (Depending on the situation, during seller financing, you're able to roll the note and the installment payments into a deferred sales trust. Depending on your income needs, you can reduce your income stream and let those payments keep growing tax-deferred)

E: Some combination of the above.

In summary:

Including a section 453 structured installment sale note in a 1031 exchange can be a useful tool for deferring taxes on the gain from the sale of an investment property, but it requires careful planning and compliance with the rules and requirements of the 1031 exchange process.

Sera Capital helps clients by acting as a fee-only fiduciary focusing on tax-efficient exit planning. We offer DST 1031 exchange services through special situations where investors could put 1031 real estate into a securitized property while deferring taxes.

Schedule a free 30-minute call today.

The Benefits Of Investing In 721 Exchange Properties For Passive Income

Real estate investors who want to defer capital gains taxes while diversifying their holdings might consider using a IRC Section 721 exchange. Section 721 of the Internal Revenue Code permits an investor to swap investment or business property for shares in a Real Estate Investment Trust (REIT) or an Operating Partnership without triggering a taxable event.

The transaction allows investors to increase the liquidity and diversification of their real estate interests while postponing the relatively expensive capital gains and depreciation recapture taxes that may occur from property sales.

While many of our articles speak to the advantages and disadvantages of an investment, this one only talks about the advantages.

What Is Section 721 Exchange?

A 721 exchange is also known as an UPREIT (Umbrella Partnership Real Estate Investment Trust). These laws allow a taxpayer to exchange business or investment property for REIT shares. An REIT is a form of investment firm that buys and sells commercial real estate.

Rather than selling the property, the owner exchanges it for Umbrella or Operating Partnership (OP) units, which can then be turned into REIT shares or cash. Although OP units and REIT shares are substantially and economically equivalent, and the REIT pays distributions to both, only REIT shares can be liquidated.

How Does It Work?

After holding a 1031-exchange replacement property for about 24 months, the owner can then undertake a 721 exchange. At this point, the property is contributed to a REIT in exchange for its value in Operating Partnership (OP) units, without having to pay capital gains taxes on the sale and depreciation of commercial property.

After one year, the investor may convert the OP units into REIT shares or cash. This conversion, however, is a taxable event if conducted within the owner's lifetime. After the owner's death, the heirs can convert the OP units to REIT shares or cash at current market value without paying capital gains taxes. This estate planning technique provides those heirs with a step-up in cost basis and allows them to receive the proceeds quickly and let them do what they'd like at that time.

The Benefits Of The Section 721 Exchange

In a normal property sale, the seller would pay taxes on both the realized capital gains and the depreciation used to defer taxes on the property's income. Capital gains and depreciation recapture taxes could amount to 20-40% of the gains realized upon sale, leaving the investor with less capital for reinvestment. A Section 721 Exchange allows investors to avoid taxes and keep their wealth working for them by exchanging investment property for shares in an Operating Partnership in a tax-deferred exchange.

In an Operating Partnership structure, the 721 Exchange allows an investor to diversify across geography, industry, tenant, and asset class. As a shareholder in the Operating Partnership, the individual investor gains access to a diverse portfolio of real estate and is no longer reliant on a single asset for cash flow and appreciation. The Operating Partnership can give the same continuous benefits as real estate ownership, such as income, tax depreciation, principal pay down, and appreciation.

The Operating Partnership can continue to make purchases in the future. This permits the investor to take advantage of future buying opportunities in the Operating Partnership without incurring any capital gains or depreciation recapture tax consequences.

Other Benefits of Investing in 721 Exchange Properties As An Investor

Considering Investing in 721 Exchange Property?

Before implementing a 721 exchange, the details and qualifications should be thoroughly considered. If an investor uses a 721 exchange, it's crucial to remember that REIT shares are not qualified for a 1031 exchange. Therefore, the only options are reinvestment or liquidation. In terms of tax-deferred exchanges, a 721 exchange ends an asset's lifeline.

Furthermore, estate inheritance is a common use of a 721 exchange because liquidation during the original owner's lifetime is a taxable event. Before completing a 721 exchange, consider the current value of the REIT's shares. If the shares are expensive, investors may lose money as the market corrects.

At Sera Capital, we understand the workings and benefits of investing in 721 Exchange properties. That is why as an investment group, we offer our clients the opportunity to take advantage of these strategies, especially when it aligns with their goals.

If you would like to learn more about Sera Capital 721 Exchange and our fee-only fiduciary offering, please contact Sera Capital today for a free consultation.

Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.”

Opportunity Zones can benefit investors considerably, and they act as a tool to receive tax benefits and other perks. Can Opportunity Zones become publicly traded? Let’s find out!

What Is an Opportunity Zone?

Qualified Opportunity Zones, or QOZs, are nominated communities certified by the Treasury Department through the state. Every state within the United States has qualified, approved zones through the department. They offer a potential federal capital gains tax incentive to taxpayers who invested in economically distressed areas within the country.

The potential tax benefits include discounts, exemptions, and deferrals from federal capital gains taxes. It has complex rules, so investors should work with tax, financial, and legal advisors to perform due diligence and understand potential risks and benefits.

Rules for Opportunity Zones

Investors who partake in QOZs have 180 days from the date of an appreciated property exchange or sale to invest realized capital gains into QOFs, which file either partnership or corporation federal tax returns for Qualified Opportunity investing. Taxpayers must invest principal returns and recognized capital gains, but only the portion of capital gains investment attribution becomes eligible for tax exemption.

While there are no requirements to invest in like-kin properties, Opportunity Zone programs allow appreciated asset sales to become reinvested into QOFs. As long as taxpayers and investors follow the rules, they can continue tax deferment and receive benefits.

Can Investors Publicly Trade QOZs?

It’s important to note that Opportunity Zones aren’t necessarily traded, as investors put asset sales capital gains directly into QOZs or Qualified Opportunity Zone Properties. Instead, investors direct capital gains into Qualified Opportunity Funds, then invest into QOZPs in federally designated QOZs. Corporations, individuals, and partnerships obtain tax-deferred benefits in return.

QOZs aren’t necessarily traded but rather represent QOZP investment funding vehicles. Furthermore, Opportunity Zone programs aren’t open to the public; they encourage investors with capital gains to put their profits into QOFs. Investors must consider costs, limitations, and long-term hold requirements.

Sera Capital offers its expertise, knowledge, and services to individuals with highly appreciated assets. Our fee-only fiduciaries provide clients with the necessary tools to achieve capital gains tax, promote portfolio diversification, and get a head start on estate planning. Our Qualified Opportunity Zone services can work as a rate-of-return vehicle and taxing savings utilization from asset sales, such as stocks, jewelry, bonds, art, and more. Schedule a free 30-minute call today if you have questions.

If you want to sell highly appreciated assets like stock, cryptocurrency, business, real estate, or another asset, the capital gains tax that may be triggered may be the most difficult obstacle. The Deferred Sale Trust (DST) is one of several tax-deferral strategies accessible to you.

The following are some disadvantages to assist you decide whether the DST is a good fit for your future exit strategy. While we usually weigh pros and cons, and Deferred Sales Trusts do have many pros; this article only emphasizes the cons.

Disadvantages of the Deferred Sales Trust

Certain Aspects Of A Sale May Not Be Eligible For Installment Treatment.

Aside from the fundamental rules, a Deferred Sales Trust has many moving parts and necessitates a complex legal structure to ensure that you are not held liable in the future for taxes that you thought were deferred. Your case may be complicated further since, while all states must generally comply with IRC 453, not all components of your sale may be qualified for installment method reporting.

For example, if you are selling your company, you must allocate the whole sales price across the various asset classes that the company has. These classes are broadly defined as follows:

Cash and Equivalents

Securities, Accounts Receivable

Inventory

Fixed Assets

Intangibles – includes non-compete agreements, trademarks, trade names, licenses etc.

Goodwill.

Some of these may be eligible for the DST "Plus" program, but not all.

Entities May Not Recognize DSTs

If you're using a DST to salvage a failed 1031 exchange, be sure your Qualified Intermediary (QI) recognizes it as a genuine exchange alternative. A QI who is unfamiliar with the approach may refuse to send funds to your Trustee, or there may not be enough time left in your exchange for your QI to finish their education and internal vetting. This can create a potential problem.

As a result, it is critical that you conduct thorough research and interview the Trustee and DST team with whom you will be working. Their general knowledge and attention to detail may spell the difference between a successful trust creation and a crippling tax bill. Even if your QI refuses, there's still another way to potentially defer your capital gains tax through Opportunity Zone Funds (OZs). With QOZs, you get to keep your cost basis, put it in your pocket, and only invest the capital gain.

Your Tax Obligation Does Not Go Away.

As with any tax reduction or deferral strategy, there is no argument against an in-depth review of the procedure with your independent accountant. Every situation is unique, and you don't want to be surprised by an unexpected tax bill. It is important to emphasize that this technique simply postpones capital gains taxes; it does not remove them.

When you start receiving principal payments from the principal investment, the current capital gains tax rate will apply. Even if you organize your trust disbursements on an interest-only basis to avoid realizing a capital gain, you will still be responsible for paying income taxes on those payments. Hiring a great financial advisor is critical. That tax payment does not go away.

Understanding and Reducing the Risks of a Deferred Sales Trust with Sera Capital

While no wealth-building method is completely risk-free, the Sera Capital investment team will work hard to ensure that you understand every advantage and disadvantage involved, as well as advise you on the best way to mitigate any potential disadvantage.

Contact us today for a free DST call or to see if you qualify for different financial structures to defer capital gains taxes on your capital assets.

Deferred Sales TrustA Deferred Sales Trust (DST) is a legal framework that allows the seller of an asset, such as real estate or a business, to postpone paying taxes on the proceeds of the sale. The seller transfers ownership of the object to the trust, which then sells it to a buyer. Rather than receiving all the selling earnings simultaneously, the seller receives payments from the trust over time (think installment sale) while the sale funds remain in the trust.

Because they are only required to pay taxes on the sale profits once they receive payments from the trust, delaying the receipt of the sale money may allow the seller to reduce their immediate tax obligations. While several tax deferment strategies exist, the Deferred Sales Trust (DST) provides you with benefits and flexibility that the others don’t. Still, it’s not for everyone.

In this article, we will look at the pros and cons of a DST to give you a better understanding of what it is and how it could benefit you.

Pros of Deferred Sales Trust

Deferred Taxation

One of the primary advantages of a DST is the ability to postpone taxes on asset sales. By transferring asset ownership to the trust, the seller can defer paying taxes on the sale gains until they begin receiving payments from the trust. As a result, the seller may be able to save a significant amount of money and minimize their tax liability and has the potential to play some tax arbitrage instead of just paying one big tax payment to Uncle Sam.

Payment Terms That Can Be Changed

A DST allows the seller to tailor the payment terms to their needs. It could entail determining the size and timing of payments and adjusting payment terms in response to changes in their financial situation. This adaptability could be helpful for sellers who want to control their income and cash flow better.

Diversification

Investing the selling proceeds in diverse assets may assist the seller in diversifying their portfolio, thus lowering risk. It could be beneficial for sellers who want to reduce their exposure to a specific asset or market.

Estate Administration

A DST can be an effective estate planning tool, allowing the seller to transfer assets to their offspring while potentially cutting estate taxes. It may increase the likelihood that the seller's money will be protected and distributed by their preferences.

1031 Exchange Rescue

For those investors who need help to successfully exit a 1031 exchange into 1031 property or a Delaware Statutory Trust, the Deferred Sales Trust may be an appropriate option, provided that your Qualified Intermediary is willing to send the investment assets to the trust. Opportunity Zone Funds are also potential backups.

Purchase Additional Property

Suppose, for some reason, you'd like to purchase additional property without having to meet the strict 1031 exchange requirements. In that case, the DST allows you to form an LLC to purchase other property without the 1031 restrictions. This will enable investors more time to make an educated decision while keeping their funds in short-term treasuries while they keep looking. You probably know you can't do a 1031 exchange for the property flippers out there. The DST may be a way for you to keep growing without taking a big haircut on every flip.

Cons of Deferred Sales Trust

Complexity

Creating and administering a DST can be difficult, necessitating the assistance of experts like lawyers, accountants, and financial consultants. As a result, it may be more costly and time-consuming than other tax-deferral strategies.

Cost

Creating and maintaining a DST may be expensive, canceling off any possible tax benefits. A DST's pricing may include trustee costs, legal and accounting fees, and other expenses.

Eligibility Restrictions

To qualify, the seller must meet specific criteria, and not all assets are eligible for a DST. It could entail having a large tax bill, being willing to postpone payment, and accepting the risks associated with the trust structure.

Risk

There is a possibility that the trust will operate differently than planned, which might lead to income loss and force the seller to pay taxes on the sale profits earlier than planned. The trust's risk is affected by the agreement's content, the trustee's financial situation, and other elements.

Step Up in Basis

While deferring capital gains taxes is the primary point of Deferred Sales Trusts, the reason why they're allowed is that our friend in Washington does receive the tax payment. There is no step-up in cost basis for those family members.

Limited Liquidity

Because the sale earnings are stored in trust and distributed over time, the seller may only have limited access to them during the trust's duration. It can restrict the seller's freedom to invest or spend the money however they see fit. Overall, a DST may be a helpful estate planning and tax deferral tool for those who qualify.

Before choosing if a DST is the best course of action for your particular situation, it is essential to thoroughly weigh the drawbacks and potential hazards of such a plan and speak with a group of experts.

Conclusion

A Deferred Sales Trust (DST) can help people manage their income and estate planning needs while delaying taxes on the sale of an asset. However, some disadvantages exist, such as complexity, expense, eligibility restrictions, risk, and a lack of liquidity.

Before deciding whether a DST is the best course of action for your specific situation, it is critical to thoroughly weigh its benefits and drawbacks and consult with a group of experts. Are you thinking of working doing a Deferred Sales Trust?

Contact us, Sera Capital, for a free 30-minute call to discuss your situation and how we can help you.

Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.”

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