Written by David Fisher
One of my favorite movies is the old western classic “San Antonio”. In the movie, Texan Clay Hardin—played by the incomparable Errol Flynn —has his cattle stolen by the bad guys and is determined to get his cattle and his friends’ cattle back. While doing so, he meets Jeanne Starr played by stunning Alexis Smith. Some guys have all the luck. In the movie, Clay gets the bad guys, gets his cattle back and gets the girl. Gotta love Hollywood.
The larger point is that Clay Hardin accomplished his goal of getting the cattle back and at the same time, got the girl. Good thing he didn’t have to choose between the cattle and the girl. In Texas in those days, women don’t always fair well when cattle are involved. To make this relevant to real estate, you could say that Jeanne Starr was “value added” to the transaction of getting his cattle back and that’s what we will discuss in our conversation.
The business world has changed dramatically and all occupations regardless of profession must adapt
The business world has changed dramatically and all occupations regardless of profession must adapt. I remember when I first started my career. It was a nice sunny day as I sat under a big tree that is now the middle of downtown Manhattan. I was trading shares of Dutch East Indies Company and Dutch West Indies Company and I was the only game under the tree. Today with a simple stock brokerage account, anyone can trade anything, anywhere at any time. Sadly they can do it without me. It’s no different when buying/selling farms and ranches. Real estate professionals have to bring more to the table to benefit their clients and that’s what is called “value added”.
For example, let’s say that you want to buy farm land to grow crops. There are numerous farm brokers in Land Magazine that can spend hours discussing soil acidity and what crops to plant based on the soil acidity. Selling a property because of the federal estate tax? There are brokers that can help or know advisers that may be able to help reduce your real estate values legally in order to reduce the federal estate tax liability. Maybe a cost segregation study can help increase the rate of return on your newly purchased investment property. Regardless of the type of property involved, Land Magazine brokers can bring “value added” to your situation.
One “value added” opportunity that doesn’t receive enough attention in a real estate transaction is what strategies are available to defer, reduce and/or eliminate taxes associated with the buying or selling of a property. Many of the farm and ranch brokers found in Land Magazine understand the “value added” brought to a transaction through these tax deferral strategies and when looking for a great ranch/farm brokers, it’s not a bad idea to find a broker who understands these strategies. It could be costly not to. Let’s take a look at some of the tax deferral strategies any broker when buying or selling property on behalf of their clients can utilize.
A 1031 exchange is widely recognized as the most popular tax deferral strategy in real estate but even a 1031 has its pitfalls and here are some of them. The first pitfall we find is when the broker is unable to find a suitable replacement property within the required identification period of 45 days. The real estate market can be both liquid and illiquid. Sometimes there are numerous properties on the market and other times there’s nothing available. That’s not the brokers fault. That’s the way the farm and ranch market works and it can be a problem to completing the exchange. If that occurs, there is now a taxable event.
A second pitfall may occur when the broker finds a great exchange replacement property but there will be a significant amount of sales proceeds left that will become taxable to the seller. A third pitfall can occur when a great property is identified appropriately within 45 days. However, after that 45 day ends, the seller has a change of heart and either decides not to sell or makes new demands from the new buyer.
The seller knows that after the 45 day identification period, the buyer can no longer look for any additional replacement properties so he must meet the new demands or have a large taxable event. Either way, the buyer loses. However, there is one flaw in the seller’s strategy and that flaw is me. I can prevent the seller from becoming overzealous in their pursuit of obtaining their best deal possible regardless of the original contract.
All three of these pitfalls can result in either an exchange not being completed or the sale becomes partially or completely taxable. The good news is that if you are working with a one of the many great brokers found in Land Magazine who recognizes “value added,” your broker will understand the different opportunity to defer taxes. There are tax deferral strategies based on the tax code such as the “1031s Always Completed Strategy” and the “Cash Out and Defer Taxes Strategy” that work well in almost every situation.
A situation that occurs frequently is when an older couple would like to sell and retire and then move closer to their grand kids so they can spoil them rotten to get even with their kids when they were rotten when they were growing up. However, when discussing their land sale with their broker and their CPA, they find out that their tax liability will be so large that the best thing for them to do is to keep the property and continue to live on it for the rest of their lives. Then the property can be passed on to the kids and they can sell using the stepped up basis assuming that will be a possibility in the future. The bottom line is that the broker loses an opportunity to sell a great property and the property owners lose an opportunity to spend more time with the grand kids because of taxes. Everyone loses.
But wait! What’s that noise I hear? Yes! It’s the 7th Calvary led by John Wayne riding to the rescue again as he has for the past 60 years. This time, he’s Captain Nathan Brittles in the 1949- classic She Wore A Yellow Ribbon. And no, he isn’t on the way to rescue the dazzling Joanne Dru but rather he’s on the way to rescue you. That’s because your broker like “The Duke” believes in “value added” and knows there are strategies that you can exercise to sell your property and defer most if not all of your capital gains tax, state tax, depreciation recapture and the Obamacare tax for as long as you like. You can also generate a larger retirement income and best of all, you can still move closer to your grand kids and terrorize your kids every day. I’m glad that I was such a wonderful child. No, really.
There are other situations where our tax deferral strategies can provide opportunities. For example, a property has several owners and each wants to do something different when the property is sold. One or more owners would like to defer their taxes or one or more would like to take the proceeds and run. A 1031 probably won’t work but one of our tax deferral strategies will. Related family issues may cause a problem for a successful 1031 but may not be a problem for our tax deferral strategies.
Selling a high end residential property will create a large tax liability and a 1031 won’t work. Our strategies will. Don’t assume that you have no options when selling a property because remember, “The Duke” and me as his wingman are ready to ride to your rescue. It’s a win-win. It’s like the Civil War. My Texan Dad told me that the South won the war and my Yankee Mom told me that the North won. So I guess everyone won.
Anyway Land Magazine Publisher Tom Alexander asked me to keep this article short. He said something about needing a few pages to show some of the great properties represented by some of the best farm and ranch brokers in the country. I don’t quite understand what he means but I will conclude with this final thought. The bottom line is that when selling or buying a great property, make sure that your broker brings “value added” to your property by buying or selling in a tax efficient manner using IRS established tax deferral strategies. Why would you let your friends at the IRS take a big chunk of your hard earned sales proceeds if you can defer those taxes indefinitely.
Now go buy or sell a great property in a tax efficient manner and then use those tax savings to invite me to your place for the weekend. Lunch is on you. Best wishes until we visit again.
David Fisher is the managing partner for Creative Real Estate Strategies. Their website is www.CRESKnowsRealEstate.com and he can be reached at (713) 702-6401 or David@CRESKnowsRealEstate.com.