Don’t pay the taxes for your 1031 exchange boot; prepare your boot to work.
Let us take an example: Suppose if you had a profit of $250,000 on the sale of your relinquished property, but your replacement property only cost $200,000 to acquire. The remaining $50,000 is considered as boot and will remain taxable if you do not invest it in any property. You can also look for a second replacement property to acquire, but you have very limited time to buy, i.e., within 45-day identification period. Likewise, $50,000 may not be enough to purchase a valuable investment property, and the investor probably may not be interested in investing additional funds out of your pocket to afford a property. So the investor might consider it by accepting the tax consequences.
But wait! We are here with a solution.
You can use the excess cash to invest in Delaware Statutory Trust (DST). The benefits of investing in DSTs are you can choose any amount you wish to invest; you do not have any limitations. You can invest the exact amount needed to evade the 1031 exchange boot – not a penny less, not a penny more than you have allocated for your replacement property. Therefore there is no need to pay any extra tax when you can invest and let it earn you additional income?
Now suppose if you don’t take our advice and put the excess cash in your pocket and pay the taxes. Now, what do you do with the cash? You must not be going to keep it in a zero to low- interest paying bank account. If you’re going to invest it, then it would be better for you to invest the total amount pre-tax rather than the after-tax amount? You can also leverage the income you’ve earned to produce higher amounts of future income when you need to defer taxes and re-invest your pre-tax cash.
Moreover, you must be thinking that paying tax on a small amount of boot is a low price to pay to liquidate some of your real estate investments and diversify your portfolio. But if you diversify real estate investments, then you can potentially have the same risk-reducing effect? When you complete your 1031 exchange by acquiring two replacement properties, then somewhere you are limiting your dependence on a single property to meet the investment goals. When you invest your extra cash into DST, then you afford to purchase a percentage of real estate properties. You can diversify your real estate portfolio and can also offer a second opportunity to earn income if your primary investment does not reach your expectations.
You must have a backup Plan
When you are near the end of your 1031 exchange transaction, then don’t be surprised by boot. You should have a backup plan. Suppose if you identify a property in DST as one of the three replacement properties, you are under the event that you have boot in the form of excess cash after the acquisition of your replacement property. You can invest the excess into DST, and your taxable boot will be eliminated.
For consultation and assistance regarding 1031 Exchanges, you can call 888-993-2835 or email us at email@example.com