We have heard recently from different “experts” that there is some flexibility in terms of when a capital gains tax must be paid. (Of course, those involved in these discussions did not avail themselves of a 1031 Tax Deferred Exchange or a Delaware Statutory Trust! See below.)
Some have indicated that the tax would not have to be paid in until the extended deadline (e.g. October 15) as opposed to April 15, at the time the extension is filed.
According to Dave Natan, CPA, a Partner with Newburg|CPA, the extension does not extend the time to pay, rather it is just an extension of the time to file. Taxpayers must pay in 100% of what they expect to owe (with the extension) by April 15. Failure to pay in by April 15 could result in penalties/interest.
Further, it is important to note with respect to ongoing federal quarterly tax estimate and wage withholding obligations, to avoid penalties, taxpayers must pay in the lesser of 100% of their prior year Federal tax or 90% of the current year anticipated tax. You must pay the lesser of 110% of prior year Federal tax or 90% of this year’s tax if your adjusted gross income (AGI) for last year exceeded $150,000 ($75,000 if married filing separately).
Some Capital Gains Deferral Options for Real Estate Investors
Two strategies that real estate investors may use to defer capital gains taxes are a Section 1031 Tax-Deferred Exchange and investing in a Delaware Statutory Trust (DST).
Section 1031 Exchange
A Section 1031 Exchange (also known as a like-kind exchange) allows an investor to defer paying capital gains taxes on a property when it is sold, as long as the proceeds are reinvested in a similar property. This is particularly beneficial for real estate investors who are looking to grow their portfolio without the immediate tax burden that comes with selling a property.
To utilize a 1031 Exchange, the property being sold and the property being acquired must be of “like-kind,” which broadly covers real estate for real estate, although they don’t have to be of the same type. For example, an investor can exchange an apartment building for an office building. The process requires a qualified intermediary to handle the proceeds and ensure the transaction complies with all the IRS rules, including strict timelines for identifying and closing on the new property.
Delaware Statutory Trust
A Delaware Statutory Trust (DST) is a separate legal entity created as a trust under Delaware state law which can be used to hold title to investment real estate. One of the benefits of a DST is that it qualifies as a like-kind property for purposes of a 1031 Exchange. Investors can sell their original investment property and use the proceeds to buy a fractional interest in a DST, deferring the capital gains taxes in the process.
The DST owns the real estate and distributes any rental income to the investors. The trust provides a way for investors to own a fractional interest in larger, potentially more profitable commercial properties that they might not be able to afford individually. Furthermore, since the DST is managed by professionals, it offers a passive investment opportunity, which can be attractive for investors not wanting to manage the day-to-day operations of a property.
Both strategies offer unique benefits and can be effective tools in an investor’s arsenal to help defer capital gains taxes and grow their real estate portfolio. However, it is important for investors to consult with a tax professional or advisor to understand all the legal and financial implications before moving forward with a Section 1031 Exchange or investing in a DST.
For further information on this topic, please call us at 781-848-9400.