The 1031 Exchange
Basics & Benefits for Retirement
In my advisory practice, I have been amazed at the number hold the funds until you are ready to close on your next of people who are delighted to discover how incredibly property (the up-leg property). You have 45 days to flexible 1031 exchanges are. The following is an identify up to three potential up-leg properties. The IRS explanation of the basics and flexibilities of this wonderful allows for this so if one of the properties you have tool. Once you understand how simple and beneficial identified sells to someone else, you still have one or two exchanges can be, you may wonder why you haven’t done of the remaining properties you can buy. In addition to the one before now. Hopefully, the benefits are impressive 45 day identification period, you have 135 days to close on enough to launch you toward your next deal. one or more of the properties you have chosen. In total,
you have 180 days from the close of escrow on your down-What is a 1031 exchange? A 1031 exchange is the leg property to close escrow on your up-leg property. process of selling one investment real estate property and That’s it! Simple rules.
buying another in its place, tax deferred, using government guidelines as outlined in section 1031 of the Internal The challenge most real estate investors have in doing a Revenue Code. 1031 exchange is to find a new up-leg property that has the
same (or greater) debt-to-equity ratio than the down-leg Just how flexible are 1031 guidelines? When the property they are selling. As long as you can do this, you Internal Revenue Code 1031 states you may exchange will have no worries about capital gains. But, if the ratio like-kind property for like-kind property, it simply means of debt-to-equity is less in the new property than it is in the investment real estate for investment real estate. If you old property, you have a tax problem. This can be a own any of the following types of investment real estate, difficult challenge, but it doesn’t have to be.
you can exchange it for any of the same or different following types of investment real estate: Land, farm, One solution many investors have used over the years is ranch, vacant lot, parking lot, warehouse, apartment to buy into a Tenant In Common (TIC) arrangement.
building, duplex, townhouse, condominium, commercial TICs have been around for decades. The approach building, office building, shopping center or mall. Of described here has been around for about the last eight course, this is not a complete list, but you have the idea. years. This TIC approach solves many problems. First For example, you can sell your vacant lot and within 180 and foremost, it allows for virtually any size equity to be days buy a shopping center or a condominium. Sell your plugged into the equation. So, you won’t be hunting for apartment building or your farm and buy an office building weeks on end in a frantic search for just the right size or commercial warehouse. Sell your parking garage or a property to fit your needs. This is turn-key. Secondly, the few of your houses and buy a strip-mall or an apartment properties from which you may select are institutional building. You can sell several properties and combine the grade or major league type properties. Many triple net TIC equities to buy a larger property. You can also do the properties have national credit tenants, the kind who pay reverse, sell a large property and diversify it among two or the rent even if they move out before their contract expires. three smaller properties. These tenants pay their own taxes, insurance, and
maintenance. If you follow government guidelines, you will have no capital gains taxes to pay on the transaction. None! You TIC shopping center properties may have tenants like Wal-can defer them perpetually into the future until it is time Mart, Target, JC Penney, Safeway, Ralphs, Albertsons, for your children or your favorite charity to inherit your Rite-Aid, Save-On Drug, Big 5 Sporting Goods, Pizza Hut, property. Under current tax law, your heirs would receive Jack in the Box, Subway Sandwiches, Baskin Robbins, a step-up in basis at the time of your passing, effectively Radio Shack, H&R Block, Bank of America, Mailboxes, eliminating capital gains taxes on the transfer. Etc., Blockbuster Video, Kragen Auto Parts, Office Depot,
JoAnn Fabrics or other national tenants. What is the next What are the rules for doing exchanges? They are: List best thing to owning these franchises? It’s having them your property (down-leg property) with whomever you pay you rent! TIC office buildings may house fortune wish or sell it yourself. Before the close of escrow, you 1000 companies or other growing corporations. Other must have in place, an accommodator, also known as an a properties may consist of light industrial, self-storage qualified facilitator or intermediary. This is an absolute facilities and mixed-use properties. must if you want to defer capital gains on your transaction. The IRS is not flexible on this point. If you don’t know TIC properties are professionally managed, and TIC where to find an accommodator, ask someone who is owners enjoy receiving the monthly cash flow while the familiar with the business. Make sure the accommodator property stays profitable. This can be ideal for is licensed, bonded, and has a good reputation. Once your conservative investors. Take the time to calculate the property sells and escrow closes, your accommodator will return on equity of one or more of your properties. Now
factor in the number of hours you spend each week managing your properties. It may surprise you how hard you are working for the return you may be receiving. Compare those figures to TIC ownership returns and you may want to take a closer look. What kind of returns can you expect? For answers, ask someone in the business, an investment advisor who specializes in this particular market niche. Unlike the regular real estate brokerage community, TIC deals are only marketed by securities-licensed broker dealers. These professionals can prove to be an invaluable resource to you.
As a TIC owner, your name will appear on the deed as having an undivided percentage ownership in the property. As with any real estate ownership, there are risks and benefits. Combined to minimize your risks and enhance your benefits are the TIC sponsor’s experience with property selection and professional management, as well as the use of non-recourse bank financing. Insurance coverage on the property is an added protection. Additional benefits are: (1) An upgrade in tenant quality, (2) Elimination of involvement in day-to-day tenant management problems, (3) Renewed deductions by way of interest and depreciation write-offs, (4) Upside potential of lease ups and equity growth, (5) Deferral of capital gains on the exchange, (6) Partially tax sheltered cash flow, and (7) Broader diversification of real estate holdings by type of real estate and by geographical location. Lastly, by combining your purchasing power with others, you are able to buy a property you might otherwise only dream of owning.
Rob Naylor is an investment advisor representative with Pacific West Financial Consultants, Inc., and a registered representative with Pacific West Securities, Inc. Member NASD/SIPC. These comments are for general educational purposes only, and do not address the entire topic. Prior to implementing any strategy, taxpayers are urged to seek the advice of their tax advisors. Call (800) 455-4750 for
questions or suggestions on topics for future articles.