You Just Gotta Ask

BY DANIELLE MEISTER, CFF, CDFA, FINANCIAL ADVISOR

This is the first month of a three-month series titled, “You Just Gotta Ask.” A series of casestudies on the importance of asking an expert before making major financial decisions.

Case Study: Can I Ever Retire fromBeing a Landlord?

Jerry had been a landlord his entire career, owning and managing eight properties. Medical issues were forcing him into retirement, and he could no longer take care of the tenants, toilets, and trash.Jerry tried a property management companybut decided he simply wanted to be done withthe burden of active real estate. His eight rental properties eventually sold for $4,500,000 and proceeds were deposited directly to his bank account. Flush with new cash, Jerry called usready to invest his money and create passive income for his retirement.
Upon our CPA-team’s review, Jerry had depreciated his properties down to almost zero,and his gain on the sale came with a massive$1,000,000 tax bill, which we could have completely avoided, had he asked the right questions before selling.

Had Jerry come to us prior to selling he couldhave used a tax-code section 1031 exchange intoa Delaware Statutory Trust (DST) investment,100% tax-deferred, or even tax-free with a stepup in basis. With a DST, Jerry could retire to the beach in Hawaii and still collect monthly rent checks (possibly more than he was collectingfrom his own rentals), defer capital gains so hiskids could inherit tax free, continue to appreciate with the underlying value of the real estate while claiming depreciation deductions for tax purposes,and not have to do any of the work. Jerry, amazed,asked if he could still get into this investment.Unfortunately, the money had already gone to Jerry’s bank account, instead of to a Qualified Intermediary required for a 1031 exchange into the Delaware Statutory Trust (DST). There was no way to reverse the transaction. Cost of not asking?A $1,000,000 tax bill.

Case Study: Vacation Property, Last Hurrah

Joe and Patricia came to us to assist with their 1031 exchange, a like-kind tax-deferred property exchange. Patricia explained they had just returned from one last hurrah, a 3-week family reunion at the home, and they were finallyready to list their $2,000,000 rental/vacation property that they had purchased decades ago for$250,000.
“Can we still sell this property via a 1031 exchange?” they asked. But they asked toolate. The answer? No. This would violate theIRS rules for section 1031 exchanges. To be considered an “investment property,” ownerscan only stay up to 15 days per year for personal use. In an audit, Joe and Patricia could owe upto $420,000 in taxes, plus penalties, if they go through with the exchange.

Case Study: The Pizza Shop and The Building

Andy, a small business owner, recently sold oneof his six pizza shops. The sale included both the business and the building. Excited about taking steps toward retirement, Andy contacted ourfirm to begin investment planning with the sale proceeds. Andy immediately mentioned howmuch he dislikes paying taxes and wanted to know every strategy to be tax efficient in our planning.
I asked him if his CPA had suggested bifurcating(or splitting) the sale of his pizza shop? He didn’t know what I was talking about. Andy had simply paid taxes in the highest 37% bracket.
I explained that when business owners are selling,they can split the business and the real estate into multiple components.
First, Andy could have bifurcated (split) the business-side of the sale. Typically (but not always), Madrona CPAs would advise more of the sales price to go to items that fall under the lower capital gains tax rate 23.8%, such as goodwillor intellectual property, versus inventory or accounts receivable which are taxed at the higher ordinary income rate, up to 37%. You can also consider a Qualified Opportunity Zone (QOZ) for goodwill gains.

Second, the real estate could have also been bifurcated (split) from the business, and the$1,600,000 fully depreciated building/land could have been a section 1031, tax-deferred exchange into another type of real estate or Delaware Statutory Trust (DST). Jerry could have paid no tax by deferring the full $320,000 tax bill. He just had to ask an expert.
Growing Your Wealth

For over 30 years, Madrona Financial & CPAshas been helping individuals and familiesimprove their financial well-being by giving them experienced advice on public and alternative investments, real estate, insurance, taxes,executive compensation, business structure and business succession strategies, advanced gifting strategies, estate planning, and more. Danielle and her staffhave offices in Park City and Cottonwood Heights, Utah, while Madrona is headquartered in Washington State.

Disclosures: DST investments are only available to accredited investors and are offered solely through the issuers offering documents. The DST sponsor determines whether to accept any individual’s subscription documents. To be an accredited investor, an individual must have had earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and “reasonably expects the samefor the current year,” according to the SEC. Or, the individual must have a net worth of more than $1 million, either alone or together with a spouse.With the passage of the Dodd-Frank Act, this now excludes a primary residence as being eligible as part of an investor’s net worth (investors who had existing accredited investments but who now fail the net-worth test without their residence being valued were grandfathered).
The information, suggestions, and recommendations included in this material is for informational purposes only and cannot be relied upon for any financial, legal or insurance purposes. Madrona Financial Services will not be held responsible for any detrimental reliance you place onthis information. It is agreed that use of this information shall be onan “as is” basis and entirely at your own risk. Additionally, Madrona Financial Services cannot and does not guarantee the performance ofany investment or insurance product. Insurance products are offered through Madrona Insurance Services, LLC, a licensed insurance agency and affiliate of Madrona Financial Services. Madrona InsuranceServices and individual advisors affiliated with Madrona Insurance Services and Madrona Financial Services receives commissions onthe sale of insurance products. Clients are not required to purchase insurance products recommended or to otherwise implement financial advice through Madrona affiliates. When we refer to preparation and filing of tax returns, tax returns are prepared and filed by our wholly-owned sister company Bauer Evans, Inc. P.S., a licensed certified public accounting firm. Madrona Financial Services, LLC is a registered investment adviser with the SEC. Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training. Madrona Financial & CPAs is a registered trade name used singly and collectively for the affiliated entities Madrona Financial Services, LLC (“Madrona”) and Bauer Evans, Inc., P.C. (“Bauer Evans”).Investment advisory services are provided through Madrona. CPA services are provided through Bauer Evans.