Utilizing Deferred Sales Trust for the Sale of a $2,000,000 Rental Property

Overview

Property Details:

  • Location: North Carolina

  • Original Property Sale Price: $2,000,000

  • Tax Basis: $500,000

  • Depreciation: Fully depreciated

Situation:

The owner of a rental property in North Carolina was looking to sell their $2,000,000 property, which had a tax basis of $500,000. Having fully utilized the depreciation, the owner faced significant capital gains tax liabilities and depreciation recapture taxes upon the sale. Additionally, the owner did not wish to reinvest the proceeds in real estate.

Objectives:

  • Minimize Capital Gains Tax and Depreciation Recapture:

    • Defer capital gains and depreciation recapture taxes using a Deferred Sales Trust (DST).

  • Diversify Investment Portfolio:

    • Reinvest the proceeds in various asset classes beyond real estate.

  • Generate a Steady Income Stream:

    • Structure payments to ensure a stable income post-sale.

Approach:

Step 1: Sale of the Property

  • The owner agreed to sell the rental property for $2,000,000.

Step 2: Capital Gains and Depreciation Recapture Calculation

  • Sale Price: $2,000,000

  • Less Tax Basis: $500,000

  • Depreciation Recapture: Depreciation on $500,000 (fully depreciated)

  • Taxable Gain: $1,500,000 + Depreciation Recapture

Step 3: Establishing the Deferred Sales Trust

  • The property owner established a DST and sold the property to the trust.

  • The DST then sold the property to the final buyer for $2,000,000, deferring both the capital gains and depreciation recapture taxes.

Step 4: Receiving Deferred Payments

  • The owner began receiving installment payments from the DST, spreading out the tax liability over time.

  • Payments were structured to match the owner’s income needs and investment goals.

Step 5: Diversifying Investments

  • The proceeds from the sale were reinvested in a diversified portfolio, including stocks, bonds, mutual funds, and other income-generating assets, aligning with the owner's desire to move away from real estate.

Results:

  1. Capital Gains Tax Deferral:

    • The owner successfully deferred taxes on the $1,500,000 capital gain and the depreciation recapture, significantly reducing the immediate tax burden.

  2. Diversified Investment Portfolio:

    • By reinvesting the deferred gains through the DST, the owner diversified their investments into various asset classes, reducing risk and increasing potential returns.

  3. Steady Income Stream:

    • The structured payments from the DST provided a stable and predictable income stream, ensuring financial security post-sale.

  4. Financial Flexibility:

    • The owner gained financial flexibility by not being tied to real estate investments, allowing for more responsive and adaptive financial planning.

Conclusion:

Utilizing the Deferred Sales Trust, the owner achieved their objectives of minimizing tax liability, diversifying investments, and generating a steady income. This case study demonstrates the DST's effectiveness in managing the financial complexities associated with the sale of a highly appreciated rental property, particularly when the owner wishes to move away from real estate investments.