By CJ Follini | NOYACK Logistics
December 20, 2022
Part Six: Taxes II
The sixth piece in the Let’s Talk Logistics Real Estate series delves deeper into taxes. Those who own commercial real estate property may have the opportunity to take advantage of significant tax benefits when investing in a REIT. These benefits stem from deferring long-term capital gains tax, which requires diving deeper into some of the tax fundamentals discussed in the last piece. Read on for this overview and a discussion of two options for commercial real estate property owners to reap these benefits. Further, be sure to check out articles one, two, three, four and five if you missed them.
Taxes 201: Long-term capital gains tax deferrals
Investors pay capital gains tax when they sell an investment for a higher price than they purchased it. For example, someone who buys a $20 investment and sells it for $25 incurs $5 in capital gains. This gain is taxed in specific long-term capital gains brackets for investments held for a year or longer. Also, it is possible to defer taxes by investing in a traditional IRA or 401(k).
One key reason to defer these taxes is to increase your overall return. Imagine an investor defers $100 in long-term capital gains tax, and that money remains in an investment that earns a 10% annual return. If the investor finally sells the investment and must pay the capital gains tax in 20 years, that $100 has now grown to approximately $670. They’ll still owe the $100, and the other $570 is subject to taxation based on the long-term capital gains brackets. Even if the investor’s in the highest long-term capital gains tax bracket, they’ll still earn roughly $450 in additional profit
Option 1: The 1031 Exchange
Those who own a business property may have two opportunities to reap this type of tax benefit. The first is through a 1031 exchange, which allows someone to defer paying capital gains tax when selling a property. Specifically, the property owner must reinvest the funds into a ‘like-kind’ property defined by the IRS, though most real estate properties meet this criteria. However, note that U.S. properties must be exchanged with other U.S. properties and non-U.S. properties must be exchanged with non-U.S. properties.
Investors can use the 1031 exchange when investing in a REIT. Specifically, they would sell a business property into a Delaware Statutory Trusts (DSTs), which allows the owner to sell the DST to an affiliated REIT manager through electing a 721 exchange (discussed below). By doing this, any funds subject to capital gains tax would instead remain invested in the REIT, so the owner could defer paying those capital gains until they liquidated their assets from the new property.
Option 2: The 721 Exchange
Another option for commercial property owners is a 721 exchange, or an UPREIT (Umbrella Partnership Real Estate Investment Trust) transaction. Rather than sell the property like in a 1031 exchange, the property owner contributes it to a REIT fund. They then become an operating partner of the fund via ownership units that can be converted into REIT shares. Throughout this process, capital gains tax is deferred until the original property owner liquidates the ownership units or REIT shares.
Beyond the tax benefits, an UPREIT exchange comes with additional benefits:
Those who are interested in NOYACK’s logistics REIT can explore whether they qualify for a 721 exchange.
*Please consult a tax professional about your personal portfolio and tax needs.*
Future articles in this series will dive into the various ways that our logistics REIT can add value.
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