Freedom From Capital Gains Tax
Brett Swarts
Amazon best selling author of Building a Capital Gains Tax Exit Plan, Closed over ? Billion in Deferred Sales Trust + Real Estate, and Founder of Capital Gains Tax Solutions
Brett Swarts founder of Capital Gains Tax Solutions guest on The Real Estate Lab Podcast with Vee Khuu. He proposes an alternative to the dreaded 1031 exchange with a proven tax deferral strategy; Deferred Sales Trust. Here is a sneak peek of their conversation.
Transcript:
Brett Swarts: [00:11:43] Only about 80 percent of the funds can be set up to this LLC to buy a new property. The other 20 percent stay with the financial advisor. But again, if you could buy at a discount or buy when a deal makes sense. We love that.
Brett Swarts: [00:11:57] The second part about it is you get a new depreciation schedule and it 1031 to change. You have to when you part of the 1031 exchange rules is when you trade the depreciation schedule travels. So one of the main reasons to own real estate investment real estate is to offset the income with depreciation write off. But if you own apartments for over twenty-seven and a half years or commercial property for thirty-nine, you deplete all of your depreciation. And at that point, the income’s coming in with no tax break from the depreciation. The deferred sales trust. On the other hand, when you buy, it’s a brand new depreciation and the depreciation just doesn’t travel.
Brett Swarts: [00:12:35] So you get a whole another set of depreciation, which is really nice. So those are the main reasons people would consider deferred sales trust versus just a 1031.
Vee: [00:12:47] Ok, so you mentioned that the first sales trust, you have a brand new depreciation schedule. Right? If I just parked the money into the deferred sales trust.
Vee: [00:12:56] And I don’t buy anything else as at all. I just parked it there. And, you know, I assume you invest it somewhere with the Goldman Sachs of the world, Merrill Lynch, and you get a certain percentage gain every year.
Vee: [00:13:12] So how does the depreciation work at that point? You’ve I don’t ever buy any more property.
Brett Swarts: [00:13:17] Right. Good point. So you’re correct. It only works with and when you buy more investment real estate.
Brett Swarts: [00:13:24] Such as invest into syndication, buy by the funds, be invested in other deals, so yeah, if it’s stocks, bonds, mutual funds, it’s just sitting there, then you’re right. There’s no depreciation.
Brett Swarts: [00:13:37] But when you find a deal again, let’s imagine there’s a million sitting in the trust. A hundred thousand dollars the next day can be sent to an LLC that you form Vee and you’re the managing member of and that that you then buy into an investment, real estate, syndication deals, multiple ones or just just just one of your own.
Brett Swarts: [00:13:59] And that right there gives you a brand depreciation schedule as opposed to doing 1031 into that same property. The schedule would have traveled. So. So that’s a good point of clarification.
Vee: [00:14:13] Ok. So and then a question I have is let me just take a step back to see if I understand the structure for the trust correctly or not. What I see is you have an A-side and a B side. The A-side, myself as the seller, I’m selling the property to the deferred sales trust with an owner carried note at a certain percent, correct.
[00:14:37] Correct. OK. And then on a B side, the deferred sales trust will sell the property to the B side buyer where they get a new loan and then they pay cash to fund this trust. Correct. Exactly right. OK. So when I set this up as the trust and you mentioned early, I can take 80 percent of the funding out to do to create a new LLC. And buy into something else. Is that a note that the trust is giving this new LLC or how does that work?
Brett Swarts: [00:15:13] That’s a J.V. partnership. So if it was a loan, they would be taxable and it’d be considered constructive receipt and therefore you’d owe the tax. But if you just J.V. partnered with the trust, then it’s not it’s a non-taxable event and you’re going to own that deal with the trust. So typically it’s a 90 10 split. OK. OK. You in the trust, even though the trust puts up 100 percent of the down payment, but 90 percent goes to you, Vee personally and 10 percent of the trusts. Again, even though the trust puts about a percent of the down payments, that’s a really nice structure that’s very favorable to you. And also very tax-efficient to get that that brand new depreciation schedule.
Vee: [00:15:56] So I can see this is almost like the inception. You keep on doing this, right. You have a deferred sales trust number one giving you 80 percent to go out and buy a property in J.V. With this trust you in this new company, you have 90 percent of it and the trust has 10 percent.
Vee: [00:16:15] Then when you sell the second property. So you personally, are you liable for 90 percent of the gain?
Brett Swarts: [00:16:24] Correct. And so you can do two things with that. You can roll it into the trust or you can do a ten thirty-one with that 90 percent. And then you just pay back the trust with its preferred return and the original investment it put in if you wanted to maintain 100 percent tax deferral. And by the way, most of our notes, they earn eight percent. And that’s what. And then they pay out about six and a half percent and their 10-year note terms. Ten years. But at the end of 10 years, you renew for 10. And then keep renewing for 10 for as long as you want. And then it can pass inside of your estate to your heirs. And your heirs continue to be in that position to just received the payments and or do what exactly you’re doing, buying and selling real estate. So the idea of the bigger picture is to sell.
Brett Swarts: [00:17:05] When you want to sell, get out of debt. When it’s smart to get out of debt and then wait for that right deal to come in place. And then if the right deal comes tomorrow or it’s in a different marketplace or a different product type with a different operator, you have the freedom with up to 80 percent of that funds to invest in those other deals and take on debt if you want to. By the way, it doesn’t have to be all cash. You can get debt and buy those deals. But we think it’s just it’s smart to take on debt when prices make sense. It’s not so smart to take on debt when the prices are really high because that puts a lot of risks. And again, 1031 is typically one entity trading for one entity. And all the risk is on you Vee, whereas the deferred sales trust, you can take 80 percent and put all the risk on the trust in you if you want to. But you may want to dis diversify into different product types. You could go into mobile home parks, you can go to senior housing, you go to multi-family, you can go into multiple geographical locations. So you’re diversifying your commercial real estate holdings. And then also the other percentage of it could be in stocks, bonds and mutual funds of your choice as well. Very conservative allocations that are paying you a nice, nice return. But the key is you can be completely out of debt. And it’s also very flexible to go back into real estate if and when you want to and really we have to say at an optimal timing, which is, I think the key to everything here, if you can buy right at the right timing and given enough time, if you see enough pitches, if imagine your baseball player, you’re gonna see that right pitch and then you can actually hit it. But if you’re faced with a lot of pressure to have to overpay. And oftentimes you’re going to swing at a wrong pitch and it could you could strikeout. And that’s what we want to avoid.
Brett Swarts: [00:18:39] And also, by the way, the deferred sales trust for your listeners, it works for high-end primary homes. We did a recent deal. Newport Beach has twenty-six million dollar sale and we helped a couple deferred $6 million in capital gains tax beyond their exclusion and they needed to sell.
Brett Swarts: [00:18:54] And they lived there two of the last five years. So they had that 121 exclusion, which five hundred thousand is exempt. But beyond that, they owed $6 million. And so 1031 does not solve that. The deferred sales trust does. And so we saved them all of that. And then again, once the funds are there, they can put in stocks, bonds, mutual funds, or back into commercial real estate and live off the interest. It also works for the sale of businesses.
Brett Swarts: [00:19:16] So most businesses, they don’t do 1031 exchanges or they just sell it. And so we do is we just say, look, do a deferred sales trust and go back into real estate. And so that’s also a big bonus. And this also works for collectibles or works for artwork or works for private stock or works for it can work for public stock. It works for any LLC, LLC, S Corp, C Corp’s partnerships. So it’s very flexible for that.
Vee: [00:19:47] Is there any limitation for this strategy?
Brett Swarts: [00:19:49] You know, the only real limitation is where and how the funds are invested. So you can’t direct those 80 percent to a primary home that’s considered constructive receipt. You can’t live in the home that you’re investing in. So it can’t be a primary home. Also, the investments must be within the United States. It can’t be foreign investments and needs to be used to be basically nothing outside of the US and not a primary home. But everything else as long as it’s investment purpose it can do. It can invest in businesses it can invest in. It can do hard money lending. It can do commercial real estate, stocks, bonds, mutual funds. One of the downsides to it, which is important to note to your listeners, is 1031 maintains the stepped-up basis. And the stepped-up basis is really not a neat thing where you can essentially if and when you die, which we’re all going to die. But when we die, as it stands today, our heirs get a stepped-up basis on our estate as and that is the good meaning they could sell and walk away from tax-free.
Brett Swarts: [00:20:49] The deferred sales trust does not do that. And it is actually an exit strategy that defers. And therefore, if and when they cash out of the trust of they’re going to pay capital gains tax. However, that being said, you know, many in Congress, they’re looking for ways to pay for this 22 trillion in debt. And they’re talking about taking away the 1031. They’re talking about taking away the stepped-up basis or limiting it.
Brett Swarts: [00:21:15] So we don’t know if that will even be around by the time these.
Brett Swarts: [00:21:20] Changing and some of the bigger picture going on to the Dimension is that there are 17 trillion dollars that’s going to pass from one generation to the next. And this is the largest wealth transfer in the history of the world. And this is by the baby boomers. OK. The baby boomers are the second-largest generation in the history of the world, and they’re passing all this wealth. There’s about 77 million in the U.S. alone. And about every single day, about 10000 baby boomers turn 65. And they’re trying to figure out a way to get out of the toilets, out of the trash out and liability. I don’t have to manage employees how to get out of debt, but they’re faced with 30 to 50 percent of their game being wiped out by capital gains tax and depreciation recapture. So this is the biggest problem facing these baby boomers who want to retire, who want to enjoy, you know time, travel, liquidity and diversification. They’ve gone through 2008 and they don’t want to face that again. They’re 10 years older, 11 years older. And they’re saying, man, I want to get out of debt. I want to diversify. I don’t want to get stuck with a property in a location when the market shifts or get stuck with banks that won’t refinance my debt. And so most either don’t sell 1031 exchange and maybe take on too much debt. But we want to give them another solution with the deferred sales trust.
Check out the full Podcast Episode Link below.
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