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Tax Mitigation Strategies

Posted: 1/10/2019
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Deciding to sell your self storage business can bring up a lot of questions. One big question that sellers typically have is about taxes and how they will impact the sale.

When it comes to tax mitigation, there are several strategies and tactics that may be right for you and your circumstances. Tax mitigation involves the use of the law to achieve anticipated tax advantages embedded in tax provisions.

There are many different strategies to taxes. These are a few options that might be right for you:

1031 Exchange

A 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes.

Pros

  • Deferral of taxes. 
  • Leverage and increased cash flow for reinvestment.
  • Relief from management.
  • Wealth and asset accumulation.

Cons

  • Multiple procedures, rules and regulations to follow.
  • Difficulty in meeting IRS rules and regulations.
  • Reduced basis on property acquired.
  • Losses cannot be recognized.
  • Only tax deferred, not tax-free.

Reverse 1031 Exchange

A reverse 1031 exchange is a tax deferment strategy that is used when the replacement property must be purchased before the old property is sold.

Pros

  • Allows for tax deferral.
  • Allows owner to purchase a new property and still defer taxes before the old property is sold.
  • Allows for tax deferral.

Cons

  • It is more complex than a conventional 1031 exchange.
  • Requires careful planning.

Selling the entity vs the real estate 

Businesses can be sold and their assets transferred, either through an asset sale or an entity sale.

Pros

  • Allows you to avoid recapture tax.

Cons

  • Potential liability concerns by the buyer.
  • Significant taxes on the entity could occur.

UPREIT structure/OP units 

‘UPREIT’ is short for “umbrella partnership real estate investment trust” and is an alternative to a 1031 like-kind exchange as a way to defer capital gains liability when an individual or company wants to sell appreciated real estate. Instead of selling the property, the owner contributes it to an UPREIT in exchange for securities called "operating partnership units" or "limited partnership units."

Pros

  • Does not create a taxable event.
  • Can diversify your portfolio, as an investor in an UPREIT is not considered a real estate property owner.
  • Gives the owner a new stake in an entire real estate portfolio and that portfolio’s income stream.
  • Provides liquidity and flexibility.

Cons

  • If the UPREIT liquidates during the contributor’s lifetime, this would be taxable.
  • The number of partnership units the contributor receives depends on the current market value of those units.
  • The underlying value of the partnership units are subject to fluctuations in the market. An investor’s “paper” gain can quickly decline or vanish completely, in the event of unforeseen circumstances or a market correction.

Installment sale

An installment sale is a sale of property in exchange for a promissory note and at least one payment after the tax year in which the sale occurs.

Pros

  • Receive interest on the full amount of the promissory note, typically at a higher rate than you could earn from other investments.
  • Defer taxes and improve cash flow.

Cons

  • Risk that the buyer does not make all of the payments.
  • You could have to deal with foreclosure and associated legal costs.

Sell and pay your taxes

Selling your assets and paying your taxes can provide you with liquidity, which provides you with the ability to de-risk and diversify your investment portfolio.

Pros

  • Generates liquidity.
  • Fully capitalize on high valuations in a seller’s market.
  • Able to fully capitalize on better buying opportunities during the next market correction.
  • Eliminates all management responsibility.

Cons

  • No longer have an income producing asset.
  • Will pay capital gains taxes.

Do not sell and hand down to kids 

Holding on to your property and eventually passing it down to your children could potentially prevent you from paying taxes.

Pros

  • Kids could continue running the family business.
  • Great asset for children to inherit.

Cons

  • Kids may not want to take on the responsibility.
  • Ongoing capital expenses.
  • Upon inheritance, children will eventually have to pay capital gains taxes on the amount that the asset has appreciated, over the value of when the estate settled.

Do not sell and refinance and pull out equity tax free

Refinancing your property and pulling out equity tax free is a great option if you are looking to free up capital.

Pros

  • Non-taxable event

Cons

  • You may end up with a higher interest rate or more onerous loan terms.
  • Cumbersome and sometimes an expensive process.
  • Still exposed to all the market & operational risks

Understanding how the structure of your business will affect your exit strategy is a key element to executing a successful exit plan. Knowing the tax implications of a sale will give you a clearer picture of what the sale means in real after-tax dollars and will provide you with the knowledge needed to make the best decision in terms of the tax mitigation strategies you choose to implement.

About SkyView Advisors

SkyView Advisors have completed more than $1.8 billion of career transactions. SkyView is unique in the industry with its exclusive focus on self storage purchase and sale. For more information about calculating cap rate or about obtaining a professional valuation of your self storage property, contact SkyView to arrange a consultation.

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