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Case Study: A Fair Exchange

Can a tax-deferred property exchange help fund a divorcee’s financial plan?

The following is a hypothetical case study that demonstrates a proposed approach using a 1031 Exchange for real estate property awarded to the divorcee.

SITUATION

Following divorce proceedings, the husband owed the wife a $2 million lump-sum settlement. He offered to deed her a property worth $2.25 million to settle the amount owed.

APPROACH

While this transaction appeared to offer the wife additional value over the agreed upon divorce settlement, it carried a basis of $500,000 with it. If the divorcee sells the property for access to the funds on the open market, she will owe approximately $405,000 in capital gains taxes. To minimize the tax impact on the client, a 1031 exchange on the real property purchased by the husband could be recommended:

–Section 1031 of the Internal Revenue Code of 1986 provides an alternative strategy for deferring the capital gains tax that may arise from the sale of a property

–By exchanging a relinquished property for “like-kind” real estate, property owners may defer their federal taxes and use all of the proceeds for the purchase of replacement property

–To execute the 1031 exchange of the real property, LD Lowe could recommend the wife take the property in her name via the deeding process; then, using a qualified 1031 intermediary, follow the 1031 process to sell the property and purchase a professionally managed set of diverse properties yielding an annual dividend of approximately 7%, net of cost

–Additional capital gains profit would be deferred using the same 1031 exchange procedure
–Capital gains retained and used for future purchases of like property could add an additional 4% annual return to the total annualized gains for a total of approximately 11% annualized

–This process could be simplified by holding all the professional real estate properties purchased in a DST (Delaware Statutory Trust), which could also allow for a step-up in basis for all heirs on all properties in the client’s DST real estate portfolio at her passing

PROJECTED RESULTS

Following the 1031 Exchange and the transfer of the property into a dividend-paying real estate portfolio, the client could:

–Realize $405,000 in capital gains tax deferral from the basis of the original property received in the divorce settlement, giving her $405,000 in purchasing power to raise her income (while avoiding the nasty surprise of realizing she owes $405,000 in taxes on the property she just received if she wants to sell it to have income)

–As a dividend-paying asset, the new real estate property could generate cash flow while incurring taxes only on the amount used for non-1031 exchange purchases

–This newly-generated excess income from the real estate portfolio could fund the client’s retirement plan and improve her legacy