Richard Hoe has been a friend of mine for over a decade. He’s been a writer for financial journals for over 50 years and a columnist for three national magazines. I had lunch with him and didn’t realize he wanted to write this article until he sent it to me. Please enjoy.
Commercial Real Estate Miracle— the GDF Financial 1031 Exchange by Richard Hoe
Dozens of real commercial sale stories like this one happen yearly. While the names—except for 1031 DST specialist Glenn Fredrickson and his company, GDF Financial—and locations in this story aren’t real, they are an example of what happens when commercial real estate brokers and sellers work with 1031 specialists like Glenn.
Bobbie Moreton is a commercial real estate broker. Her client and friend, Larry Halston, owns a mid-sized building in an excellent location in Gunter City. There are six offices, all with long-term leases, on the second floor. The ground floor is leased to a hardware store.
He said to Bobbie, “There’s tax to pay, and I need to wind up after the sale with enough to give Sarah and I a comfortable retirement income.” Even so, Bobbie could never find a buyer with more than $1.5 million to spend, and there were not too many buyers willing to spend that amount.
Larry is 72 years old, and would like to retire, but he knows from talking with his CPA that retirement income could be difficult. If he sells, he’ll have to pay the following:
Capital Gains tax;
Depreciation Recapture tax; and the
Tax on Net Investment Income.
If he sells the building for $1.5 million, his CPA worked out that he would only wind up with about $1.125 million after taxes are paid. That’s why he won’t sell the building for less than $2 million.
In the meantime, Larry had the hassle of owning and caring for the property. He received net income of about $80 thousand yearly. He had paid off the property mortgage years ago.
From time to time, Bobbie would check with Larry, and then go searching for what she thought would be a willing buyer. Bobbie had had enough, and she decided to focus on solving the problem—the 25% difference between what Larry wanted and what she might be able to sell the property for. Bobbie calculated that what Larry really wanted was income—at least $75 thousand yearly.
After a visit to the business section of the Gunter Library and some Google searches, Bobbie thought that a 1031 exchange, using a simple trust, might be just the ticket. She got in touch with Glenn Fredrickson, a specialist, who said he was used to structuring arrangements for people like Larry. The advisor said that by using the 1031 exchange provisions in the tax code, Larry could sell his building for, say, the $1.5 million price that was 25% less than he wanted, and then move the money to a real estate partnership, managed by its general partner and a staff. The partnership would have a finite life and, if it ended and made a distribution of capital, with or without capital gains, Larry could use the 1031 technique again, moving the money and any capital gains to a new partnership.
One main ingredient of the arrangement is that Larry can avoid capital gains by passing his interest in one partnership or its successors to his children. When he dies and his children inherit, the partnership interest receives a step-up in basis, meaning that there are no capital gains, and therefore zero capital gains taxes. In Larry’s case, he built the structure years before for an all-in cost of less than $250 thousand. Despite the improvements, the property had more capital gains embedded than it had cost basis. When the new partnership (or its successor) liquidates, the kids will likely have some capital gains from the partnership itself, but the basis will be roughly $1.5 million, nowhere near the amount of taxes that Larry would pay, especially if Larry sold at his dream price of $2 million.
The other main ingredient is simple—the $1.5 million participation in the DST produces an annual income filling in his income gap. And, from now on, Larry won’t have to deal with tenants, make repairs or receive police calls at midnight saying that the offices have been broken into. Larry and his wife Sarah’s new yearly income, including income from the 1031-exchanged real estate partnership, will be about $140 thousand. The tax rate will now receive the benefits of depreciation and interest rate deductions. This means their after-tax money is more than it was when they ran it.
The out-of-pocket costs for the 1031 DST exchange equal zero. The minor transactional costs are part of the structure of the exchange. For commercial property owners of a certain age, the 1031 DST exchange is a miracle, providing reliable income and freedom from management worries, like insurance premiums and hot water heaters. And it allows sellers to dramatically reduce capital gains taxes, receive healthy income, and preserve capital for children.
Contact Glenn Fredrickson at (405) 778-4888 GDF Financial Glenn@GDFfinancial.com
Richard Hoe is a freelance writer. His byline has appeared in national professional journals, including The National Underwriter, Life Association News and others. He has been a columnist for three national magazines. His email is firstname.lastname@example.org.
*Colorado Financial Service Corporation and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide,and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.