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3 key considerations in real estate succession planning

Jan 08, 2023

You’ve worked long and hard to create a thriving real estate business over the years. With your focus on building a company and managing funds or properties, it’s not surprising that you’ve had little bandwidth or interest in tackling the looming question of what comes next.

But as you prepare to step back from your day-to-day role, it can feel daunting to address these challenges and devise a plan that meets your needs and goals. Does your plan include transition to a family member or key employee or another ownership group? Are your retirement assets protected from various economic risks? Do they provide you with enough liquidity and cash flow to maintain your lifestyle? Is there a significant looming income or estate tax bill that needs critical planning to mitigate?

Here are three key considerations as you prepare for the next chapter of your business:

1. Your succession team

While you’re at the helm, it’s important to identify your successor and develop a succession plan. Is there a key employee, family member or an outside development group who can step into your existing platform? It can be hard to contemplate a future for the business you built up without you in it, but when you think about the needs of your employees, how important is it to you that you preserve their jobs and livelihoods when you are no longer on the scene?

If your business has multiple components, you may prefer a separate approach for each element. Is there a particular successor for your development business but perhaps a different party who should handle property management or asset management if you retain ownership? Third-party organizations can handle many of the day-to-day responsibilities, but you will have to determine whether giving up control for a fee is acceptable.

2. Wealth preservation

Are all or most of your assets accumulated in real estate? Have you sufficiently hedged against potential economic and inherent market risks?

If you’d like to keep your investments concentrated in real estate, take a close look at your product mix and inherent asset stability. If you own all office buildings in a downtown metro area on a variable interest loan with no rate cap, you could be in trouble. Furthermore, does your real estate portfolio provide a sufficient ongoing cash flow or access to liquidity in case of an emergency?

A wider diversification strategy or financial plan to protect your wealth may involve improving your access to liquidity or making investments in other asset classes. Investing solely in real estate can lead to a highly illiquid situation when markets turn, so having a diversified income stream is important. Take a close look at whether you have the right mix of stocks/bonds, cash savings, alternative investments and, most importantly, real estate, class mix in your portfolio.

3. Tax management

Tax planning is a crucial component to understanding the impact that your succession will have on both you and others. If you are currently looking to move to a less active role in real estate but want to maintain your wealth in real assets, then looking into some different tax deferral strategies can help.

For instance, doing a 1031 exchange with a property you are currently actively managing to a DST structure will enable you to maintain ownership of real assets but have no active management.

If you would prefer to keep your property yet diversify into a potential larger portfolio of assets, exploring a 721 property contribution into an UPREIT structure or similar private real estate fund structure is another potential option. This would hand over the management of the property to a REIT or similar asset management team, but you won’t need to pick up any gain immediately if planned correctly.

Both of these tactics will prevent a current tax bill and defer gain to allow for a greater step-up in basis for your assets transferred to your beneficiaries as part of your estate plan.

Note also that the current estate tax exemption of $12.92 million is set to sunset in 2026 and return to only $6.8 million. Thoughtful consideration should be given to assets held and transferred as part of the estate and assets that are fruitful to be gifted and transferred during your lifetime. Exploring family limited partnerships and similar trust strategies (e.g., IDGTs, GRATs, etc.) can be vital components to maximizing the wealth transferred to the intended beneficiaries.

Additionally, ensuring that your estate is liquid enough to pay any estate tax needed is imperative. Since much of your wealth may be tied up in illiquid real estate, it can make an estate tax bill problematic for making prudent and timely business decisions that maximize the value of your real estate. It’s important to understand the potential tax liability as well as how it will be paid.

Creating the right action plan

Every real estate owner has a unique and often complex series of issues to sort through to determine their next steps. Wipfli real estate specialists can help make that process easier and more advantageous for you. We have deep experience in working with real estate owners, developers and asset managers to make the right decisions in their transition and succession planning. Contact us and learn more about the full range Wipfli’s real estate services.

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Cory Bultinck, CPA, MBT
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Dannielle Lewis, CPA
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