Alisa Wolfson
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Question: My wife and I are both 71 and own rental real estate in San Jose, California that we’ve had for decades. The equity is worth millions, and I have a property manager. I have a pension, very small Social Security income and a large rental income. We have more than enough for all our expenses and have savings and stocks, too.
We just moved to North Carolina. My wife, family and friends would love us to have a simpler life without the hassle of rental real estate. I did do a 1031 exchange a few months ago that went well, but still puts us in the role of rental ownership. It seems to me that the equity build up in the Bay Area is hard to find elsewhere. I don’t need more monthly income, but I feel stuck because of the hundreds of thousands of dollars in capital gains taxes I would pay to sell. Who would be the right professional to help me and what should I be asking them to do? (Looking for a new financial adviser? This free tool can match you to a fiduciary adviser. )
Answer: We hear you (loud and clear!) on wanting a simpler life, so you might want to entertain a few scenarios, pros say. Firstly, certified financial planner Jim Hemphill at TGS Financial says to challenge your assumptions about Bay Area real estate: “You may feel that the Bay Area has a permanent advantage for real estate equity build up, but lots of owners of office buildings in downtown San Francisco would disagree. Any investment that can make you real and serious money can also lose you real and serious money. Period. Without exception. You really do have most of your eggs in one risky basket.” In other words, you may want to think about diversifying your portfolio.
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Think, too, about how much those capital gains taxes will hurt you, versus what you gain from selling. “I suggest you reframe your thinking about capital gains and instead of focusing on the large tax you’ll pay, consider the much larger amount you’ll have after the taxes are paid. Remember, too, that the tax is only on the gain, not the full value of the property,” says certified financial planner Kenneth Robinson at Practical Financial Planning.
If you bought property for $1 million that you’re now selling for $4 million, a 20% capital gains tax on the $3 million dollar growth is $600,000. “That’s a lot, but it leaves you $3.4 million and a simpler life without the hassles of rental real estate. Run the numbers so you can put actual dollar amounts to the results if you were to sell,” says Robinson.
Indeed, taxes are a fact of life, so you’re going to pay one way or another, Robinson adds: “Either in the form of tax liability or in the continued burden of owning rental real estate.”
If it’s just too much to pay, you can put up with the hassle for the rest of your life and then leave the property to a family member, Robinson notes. “They’d get a step-up in basis and while they could sell it soon thereafter, they could be the ones stuck with the rental real estate at that point,” says Robinson.
If you can’t stomach the capital gains, another 1031 exchange (the moniker for swapping one real estate investment property for another to defer capital gains taxes) could make sense, but to make your life easier, consider properties closer to you in North Carolina, says certified financial planner James Daniel at The Advisory Firm.
Another possibility is a Delaware Statutory Trust (DST) or UPREIT. “You can complete a 1031 exchange with the trust to broaden and diversify your asset base as well as farm out the day-to-day management responsibilities. If you take it a step further, the trust can complete a 721 exchange and sell itself to a REIT or form a new REIT. This would absolve you of your management duties, defer tax and hopefully make your financial life simpler,” says certified financial planner Matt Bacon at Carmichael Hill & Associates.
Who can help you make these decisions?
“A fee-only planner with experience in real estate and taxes could be a great help in discussing the options available,” says Daniel. (Looking for a new financial adviser? This free tool can match you to a fiduciary adviser. )
But a financial adviser isn’t all you should consider. “You actually need the combined help of two or three professionals, a financial adviser, a tax professional and a tax attorney. You can find combination financial advisers and tax professionals by looking at their credentials for designations like CFP (certified financial planner), CPA (certified public accountant) or CFP, EA (enrolled agents).
“To mitigate bias against someone simply advising you to sell property so they can manage the liquid portfolio thereafter in stocks and bonds, find an adviser who is willing to work with you on a project or hourly basis,” says certified financial planner Amir Noor at United Financial Planning Group.
Advisers work under many fee structures, including assets under management (AUM), hourly and flat-rate. “You can search for advisers based on their fee structure by using Garrett Planning Network or the Fee-Only Network. Once an adviser has a comprehensive view of your personal finances and understands the ideal way in which you want to live your life, you’ll be confident in what to do. Then, the tax attorney can facilitate the legal transaction,” says Noor.
Working with a fee-only, fiduciary financial planner who is a member of the National Association of Personal Financial Advisors (NAPFA) will ensure they have no products to sell and offer advice only. “You’ll get a fair assessment of what you’re currently doing as well as the pros and cons of the alternatives,” says Bacon.
You might also consider a Registered Life Planner (RLP), as they specialize in the human aspect of financial planning by creating deeper, more comprehensive and lasting relationships with clients, to help you sort out what’s more important to you: avoiding the taxation or avoiding the hassle of continuing to own real estate. (Looking for a new financial adviser? This free tool can match you to a fiduciary adviser. )
Have an issue with your financial adviser or looking for a new one? Email picks@marketwatch.com .
Questions edited for brevity and clarity.
