The Common Misconception
When discussing estate planning with commercial real estate owners, I often hear, “We’ll just leave it to our kids,” or worse, “We’ll sell it, pay the taxes, and pass along what’s left.” If you ever hear someone say this, stop them right there! There are far better ways to preserve generational wealth and ensure your family’s future financial stability.
Special Considerations for Commercial Property
Imagine an elderly individual owning several commercial properties. These properties might have issues like vacancies, deferred maintenance, tenant collection problems, or looming debt that needs refinancing. The property may have exhausted its depreciation benefits, making it less tax-advantageous. Now consider: Do the heirs really have the desire or experience to handle these issues when they inherit the property?
Vacancies in commercial spaces present major hurdles, especially for those unfamiliar with the process. Leasing vacant properties involves significant marketing efforts, dealing with legal leasing documents, and overseeing interior construction. The time it takes to fill a vacancy could cause a cash flow shortfall that the heirs may not be financially prepared to cover.
Deferred maintenance is another substantial burden. When a major repair is needed—such as replacing a roof, repaving a parking lot, or reconstructing a façade—heirs will likely need to hire a contractor, work with an architect, obtain permits, and possibly secure financing to cover repair costs.
Then there’s refinancing debt, which is never straightforward. If the new interest rate is significantly higher than the previous one, the heirs could end up with a property that’s cash flow negative, which places a financial strain on them.
In short, “leaving it to the kids” may not be the best option. They may lack the experience, time, or financial resources needed to keep the property’s value intact until it can be sold.
Smart Solutions to Safeguard Wealth
One practical solution is converting these complex assets into single-tenant net lease (STNL/NNN) properties through a 1031 tax-deferred exchange. This strategy is a game-changer for both the current owner and their heirs. By moving assets into STNL/NNN properties, the owner simplifies their portfolio and may even boost their cash flow. Meanwhile, the heirs avoid many of the challenges associated with managing more intricate real estate assets.
When the time comes to transfer ownership, the heirs can sell the STNL/NNN properties at a stepped-up basis, thus avoiding capital gains and depreciation recapture taxes. Depending on state tax rates, this can preserve as much as 30% to 40% of the property’s value.
Planning Ahead for Success
The key to preserving generational wealth is planning ahead and seeking professional advice. Making informed decisions about commercial real estate ownership and succession is critical. As you develop your estate plans, explore these strategies, which can be far more advantageous than simply “leaving it to the kids.” Your heirs will be grateful for your foresight!