Written by David Fisher
It was a brutally cold, windy, and overcast morning in the Dakotas Territory. The year was 1871. The air exhaled by every living creature immediately turned into vapor from the freezing temperature. We were soldiers in the 7th United States Calvary Regiment and on this particular morning, we were not singing “Gary Owens.” Thousands of settlers were flocking to the territory and our job was to protect them. This very morning, many of the settlers were being threatened by the bad guys and we were preparing to ride to their rescue.
Commanding F Company was the American icon Capt. John Wayne. His second-in-command was WWII Hero Lt. James Stewart. Work with me here. We were divided into two wings. On the left, 1st Squad was manned by the legendary Virginian Sgt. Randolph Scott and 2nd Squad was led by the incomparable Sgt. Errol Flynn (before he became Custer.)
The right wing was led by the 3rd Squad’s fearless Sgt. Glenn Ford, who later helped defeat the Japanese navy at the Battle of Midway Island, and 4th Squad was led by yours truly, straight out of “The Point.” Again, work with me. The battle lines were drawn and we were ready for action. Capt. Wayne gave the order and the bugler belted out the Calvary Charge. The horses leaped into action, our swords at the ready and at that very moment…my alarm went off and it was a Wednesday morning in 2016. Another missed opportunity to ride to the rescue. Or was it?
Like those settlers, landowners are under attack and now the bad guys are some members of Congress. Landowners who are working their ranch or farm with their own hands, taking huge risks every day, paying for everything retail but having to charge wholesale for their products, having made huge sacrifices for decade after decade, and who are now ready to retire find their ability to sell and defer their huge tax liability in question.
Section 1031 is now under more scrutiny than ever by Congress as a tax loophole and that’s probably not a good thing. All of the appropriate organizations, including the RLI, are lobbying Congress to leave 1031 exchanges alone and for the right reasons. But this is Congress and that means that this issue will probably become a huge political football. I have no inside information but based on being in practice since the late 70s, my gut feeling is that 1031 exchanges will be modified to some extent. Perhaps, the first 500K in capital gains can be passed on to a new replacement property and the rest is taxable or something along those lines may be the final result.
So assuming that Section 1031 is changed in some fashion, how can RLI members ride to the rescue to still help their clients defer capital gains taxes, state taxes where applicable, depreciation recapture, the Obama Care tax, and possibly the alternative minimum tax when selling a clients’ property. Actually, there are options now and you don’t even need a 1031 to defer taxes. Let’s turn a negative into a positive.
I recognize that mentioning the following is like talking to Noah about the flood but, as all of you know, one of the biggest concerns that a prospective selling client has is the ability to find a great replacement property within the time constraints in completing an exchange. Imagine being able to tell a prospective client that, even if Congress makes changes to Section 1031, you will still be able to defer their various taxes on their hard earned sales proceeds and can do so without concern for the 45 day ID period or any other 1031 limitations. That’s right.
For example, you bring a great offer to your seller but he doesn’t accept the offer because he doesn’t feel confident that he will be able to identify a replacement property in the time frame from his closing date plus the 45 days. Well, there’s good news. You can have your seller accept the offer, close the deal, get paid, still defer taxes and at some point in the future even if more than 45 days, still be able to help your client purchase another property.
Now, imagine this scenario. You have a seller whose family has owned their property for several decades and now the landowners want to sell their property and retire. You’re in competition with another broker. The other broker makes his listing presentation and tells the prospective client why he will do a great job of selling his property. Now, it’s your turn and you make an equally compelling presentation but at the end, you ask the prospective seller one final question. “Mr. Seller, you mentioned that your family wants to sell and retire. Have you given any thought to your tax liability on your sales proceeds?”
The prospective seller says he has but there are no options other than to pay the 25–30%+ tax liability You respond by telling the prospective seller that in fact you can defer that tax liability to the next generation and turn his sale into a 5–6% retirement income and he can pass that income to his heirs if he chooses to do so. Who do you think will get the listing. That’s right. You. Because the other broker can’t do the same. And without a 1031 exchange.
Now consider this opportunity. Many older land owners refuse to sell their property because of the large tax liability that a sale will create because a 1031 isn’t appropriate and, instead, will use the stepped up basis to pass the property on to his heirs. This is not necessarily a bad strategy unless you sell real estate. Here is an idea. Since you can defer taxes without a 1031, this prospect is now in play. You can explain to the older land owner that, in fact, he can sell his property, defer his capital gains tax, state tax where applicable, and depreciation recapture on his hard-earned sales proceeds, generate about 5% appreciation on his proceeds at the same time, and, instead of that appreciation being on paper, it’s in his savings account. The bottom line is that you, the RLI member may have the ability to show the land owner why he is better off by letting you sell his property now instead of using the stepped up basis at some point in the future. Everyone wins.
The great thing about the Realtors Land Institute is the sharing of ideas and strategies—and that’s why RLI members and ALCs tend to be more successful and have higher incomes than most non-members. I certainly hope that Congress doesn’t make any changes to Section 1031 but, if they do, we can still ride to the rescue of our clients without having to be John Wayne. Let’s turn a potential negative into a positive now by recognizing that there are other innovative ways to defer taxes that also provide opportunities to sell more real estate. By doing so, you will help your sellers keep more of their hard-earned sales proceeds in their pockets and sending less to Washington D.C. and 43 state capitals. Your clients will thank you with more referrals for caring about them even after you have received your commission.
Happy selling and deferring taxes until we visit again. Contact David Fisher at David@CRESKnowsRealEstate.com or (713) 702-6401 for more information.