When working on estate planning with owners of commercial real estate, I hear many investors say “we are just going to leave it to our kids”. Or, worse, we are just going to sell it, pay the taxes and leave what’s left to our children. If you hear someone say this tell them NO! There are better scenarios to preserve generational wealth.
Special Concerns
For example, an elderly person(s) may own one or multiple commercial real estate assets. These may have vacancies, deferred maintenance, collection issues with tenants, or need to refinance debt. They may have exhausted the depreciation allowance for their properties. Their children may not have the desire, or the experience, to deal with these things if they inherit the commercial property.
Vacancy in any commercial property can create challenges for the uninitiated. Leasing vacant space involves extensive marketing, leasing documents, interior construction, and other issues. Marketing periods may cause shortfalls in cash flow that one’s heirs may not be able to cover.
Deferred maintenance can be another expensive burden for heirs to bear, especially if this involves major components of the property such as a roof, parking lot, or façade construction. To effectively handle these things, one will most likely need to engage a general contractor, architect, obtain municipal permits and possibly financing to complete repairs.
Refinancing debt on a commercial property is not a simple task. Especially if the cost of the new debt (interest payments) will be substantially higher than the debt being refinanced. The new payments may move the property to cash flow negative creating a hardship on the current owner’s heirs.
So, “leaving it to the kids” may not be in the best interest of the kids. They may not have the experience, time, or financial resources to maintain the property’s value until they are able to sell.
Solutions to Preserve Wealth
One scenario we can facilitate is to move the owner’s more complex assets into single tenant net lease (STNL/NNN) properties via a 1031 tax deferred exchange. Using a 1031 tax deferred exchange to move assets into STNL/NNN properties is a smart strategy that can benefit both the current owners and their heirs. By doing so, the owners can simplify their portfolio and potentially increase their cash flow, while the heirs can avoid some of the challenges associated with owning more complex assets.
When the properties are transferred to the heirs, they can sell the STNL/NNN properties at the stepped-up basis and avoid the capital gains and depreciation recapture taxes. This can preserve 30%-40% of the value/wealth depending on state tax rates.
It is extremely important for people to plan ahead and seek professional guidance to ensure they are making informed decisions about their commercial property ownership and succession planning. When working on your plans, consider these options that may be better than “leaving it to the kids”. They will love you for it!
Rich Vaaler specializes in helping transition commercial property ownership from a complicated, active role, into a simplified, passive position that enables a better transition to their heirs than other scenarios. He lives in Stuart, FL with his wife and maintains active offices and brokers licenses in Virginia and Florida. This is not intended to offer legal or tax advice. Seek the advice of an attorney or CPA before making any decisions.
