As market conditions have improved, we see many investors opting to sell specific current real estate holdings. In some cases, these property sales have high Loan to Value (LTV) ratios that present challenges to investors planning to pay, reduce or defer their capital gains tax. In most cases, there may be strategies to help maximize the investor’s after-tax sale proceeds.
The Investor’s Problem
For investors with a low or no taxable basis, the sale of the relinquished property can create a scenario where the capital gain is higher in proportion to the equity proceeds available for reinvestment or tax liability payment. The higher LTV creates a high level of mortgage boot. It is critical that the investor consults with their tax advisor to calculate and understand the potential tax liability created from the sale.
Illustration 1 demonstrates an example of the high LTV scenario. Based on the assumption of the sale of a $1,000,000 property with a 70% LTV and a remaining basis of $25,000, the investors could end up using a majority of the cash proceeds to cover the potential tax liability.
Potential Solution – Partial Exchange
Strategy to cash out while reducing potential Mortgage Boot and potential total Tax Liability
The investor whose objective is to cash out and maximize the amount of remaining equity proceeds from the sale may consider a strategy to help reduce the high level of mortgage boot and further reduce to overall all potential tax liability.
The investor could purchase a like-kind replacement property with a portion of the equity proceeds and a high LTV. This could be a direct property purchase with a high LTV or a DST with a high LTV. Illustration 2 demonstrates this scenario. Our example shows more significant after-tax proceeds than Illustration 1 and has a portion of the funds working for the investor and not paid as tax.
Further, this strategy can also be used in a full exchange with other cash-flow generating properties or DSTs
More information on the High LTV DST
The High Leverage, Zero Coupon DST is a portfolio of properties leased to tenants of excellent credit. A bank is generally willing to lend a high LTV amount with the assumption that the loan will hyper amortize.
All of the tenant’s rents will go to the loan interest and principal and reduce the LTV over the hold period. No cash flow is paid to the investor, but each payment should increase the investors’ equity in the DST.