Section 1031 Exchanges

August 20, 2015 by Peter Maclennan Leave a Comment

Using a 1031 Exchange to Upgrade Properties

Using a Section 1031 Exchange to trade from one property to another is a common event. Most of the time owners are seeking higher returns. In the case below, my clients were looking to go from a tired property to a much nicer property.

A Tired Duplex in Concord

Rear Unit of a Duplex in Concord, CA

I was contacted to list a property in Concord for a client. The property was a 2 unit property with great access to Concord BART. The property was not in the best of shape. It had been a rental for 30+ years and some of the tenants had beaten the property up. While listing the property we learned that one of the tenants was going to be an issue and had to process an eviction in the midst of trying to sell the property.

To complicate the matter, the owners had performed a 1031 exchange in the 1980’s when they bought the property. I advised them to consult with their CPA regarding their potential tax liability if the property was sold and not exchanged. After forwarding the estimated sales price to their CPA, she determined that the owners would likely have to pay nearly 50% of the sales proceeds in taxes. It immediately became clear that we should perform a 1031 exchange to preserve that equity to pass on to their heirs.

When we listed the property we got a significant amount of interest. We parlayed that interest into multiple offers and almost $30,000 above asking price sale.

Since a 1031 exchange has strict timing guidelines, I recommended to my clients that we include a provision that extended the amount of time we had to close the “down-leg” of their transaction.

A Nicer Single-Family Home

Rental House in Concord, CA

My clients determined that they wanted an easy-to-own rental property that was going to attract a high caliber of renters. Their plan was to pass this asset along to their heirs. Consequently, they don’t want something that is going to be high maintenance.

Thankfully, we negotiated for more time in the contract as the market was thin on investment properties. The first property we pursued was snapped up from under our noses.

Finally, after submitting offers on a couple of places my clients got into contract on a home in Concord. Using the 1031 Exchange funds and additional capital we were able to secure a purchase with an all cash 14-day closing. This appealed to the sellers as they were in contract on another home to buy. This property is a nice 3-bedroom 2-bath home with granite countertops and a killer kitchen. My clients were more than pleased with the purchase.

Transaction Recap

My clients were able to accomplish their goal of selling a property that was causing headaches and transferring the equity into another more attractive property. This transaction allowed them to accomplish their goal of deferring capital gains tax and to provide their heirs with a more attractive investment property.

It is important to have an agent that can help you navigate the 1031 Exchange Process. If you or someone you know is thinking of selling an investment property, have them give me a call for a no obligation consultation at 925.385.8798.

August 29, 2013 by Peter Maclennan Leave a Comment

Reasons for a 1031 Exchange

One of the benefits of real estate ownership is the ability to defer payment of capital gains tax on the sale of a property. This deferment is accomplished through a 1031 exchange or a Starker exchange.

Last week, I attended a seminar on 1031 exchanges. The speaker listed 4 main reasons why real estate investors take advantage of the 1031 exchange.

Tax Deferral

Currently the federal capital gains tax is 15% or 20% based on your income. California’s top capital gains rate is 13.3%. At the top tax rate a real estate investor in California could be paying almost 33% of their gain in taxes. An investor’s ability to build long-term wealth is hampered if they need to pay taxes on each transaction.

Buy “More” Property

A 1o31 exchange allows the investor to buy bigger or better property. An investor might decide to exchange into a property that is larger in price or they may decide to go into property that increases their cash flow.

Diversification

Diversification is the theory of spreading investment across multiple assets in order to reduce risk. Your grandma might say, “Don’t put all your eggs in one basket.”

Geographic Diversification. Having real estate investments in different locations and metropolitan areas spreads risk across diverse economic bases. It also limits risk to natural disasters that may devastate one area and impact real estate values.

Asset Class Diversification. Another way to diversify is to invest in different types of real estate assets. Industrial, retail, office, and multifamily assets are affected in different ways by different economic events. By owning different types of property, an investor can minimize the risks that any one asset class might suffer.

Long-Term Ownership Issues

A 1031 exchange can help alleviate some issues that arise when properties have been held for a long-time.

Management Burdens. A lot of owners of residential rentals get burned out after dealing with tenants, trash, and taxes. By exchanging out of their rental property and into a triple net investment property an investor can maintain their cash flow, but without have to deal with management problems.

Lack of Depreciation. One of the benefits of real estate investment is the ability to shelter income by the use of the depreciation expense. Properties held for an extended period of time (27 years or more) lose the ability to be depreciated. A savvy investor can exchange into a more valuable property to increase their tax basis and begin to depreciate their assets again.

Concluding Thoughts

The 1031 exchange is a valuable tool in the hands of a real estate investor. It can help defer capital gains taxes, buy more property, diversify risk, and alleviate issues arising from long-term ownership of the same assets.

February 28, 2013 by Peter Maclennan Leave a Comment

Buyers of Commercial Real Estate

Commercial real estate owners want to know the most likely buyer of their commercial investment property. This knowledge can help the owner to strategize on the marketing of their property.

The indications below are general guidelines and specific to the San Francisco Bay Area. They are not hard and fast rules, but merely meant to help investment property owners understand to whom they will be marketing their property. [Read more…]

April 25, 2012 by Peter Maclennan 1 Comment

Plan Ahead for a 1031 Exchange

Do you own a current investment or business property? Are you considering a 1031 exchange (also called a Starker Exchange) to defer the capital gains tax?

If so, plan ahead!

The 1031 Exchange Benefits

By using a 1031 exchange investors are able to defer the capital gains tax on a property by exchanging their current property for another property. Both properties must be held for investment or business purposes, they cannot be intended for personal use.

The use of an exchange allows an investor to accumulate more assets before paying taxes on previous gains.

Changes in 1031 Exchanges

1031 exchanges have been around for a long time. Many seasoned real estate investors have used them to defer capital gains taxes on their properties, thus accumulating larger assets. Recently, the IRS is under pressure to generate more revenue and is paying closer attention to all tax issues. 1031 exchanges are no exception to the IRS’ scrutiny.

The 1065 form that is reported to the IRS requests information that wasn’t previously tracked. This information can be a means of triggering an IRS audit. The “Drop and Swap” model of 1031 partnership dissolution is under close scrutiny and may require you to dissolve the entity a year prior to the close of escrow.

Plan Ahead

If you are considering a 1031 Exchange, plan ahead. Depending on your advisors’ counsel, you may need to plan as early as one year prior to the close of escrow.

Meet with your CPA or tax professional when even considering a potential sale. Your tax professional can help you plan ahead to avoid a disqualification of your exchange and undue scrutiny by the IRS.
Meet with your estate planner to make sure you end up holding title in the correct entity after acquisition.
Meet with your exchange accomodator to have them walk you through the timing and procedures that need to be followed.
Meet with your real estate professional. Let them know what you are planning to do and when you are planning to do it. Let them give you suggestions for maximizing the value of your current property. Let them help you begin to identify a replacement property prior to selling your existing property.

The guidelines and time frames for 1031 exchanges are very tight and inflexible and don’t allow for a change of heart after the fact. Planning ahead in a 1031 exchange can help you avoid mistakes that will force you to pay taxes and incur costly interest and penalties due to hasty, forced decisions.

December 8, 2009 by Peter Maclennan Leave a Comment

Selling Tax Deferred Properties at a Loss Still Can Trigger a Taxable Gain

One of the benefits of holding real estate for investment is the ability to defer taxes on capital gains through what is known as a 1031 exchange. Section 1031 of the Internal Revenue Code provides for investors to delay capital gains on the sale of property as long as they invest the proceeds in a “like-kind” (same type) investment within 180 days.

Real estate investors have been using 1031 exchanges for decades to defer gains in properties and use the proceeds to invest in larger properties. With the recent decline in real estate values and the loss of some properties through foreclosure, 1031 exchanges may actually trigger capital gains tax for real estate investors.

The California Real Estate Journal detailed this dilemma in an article on September 14, 2009.

For the thousands of people who have invested in 1031 tax-deferred exchanges, the real estate downturn may be coming home to roost.

Section 1031 exchanges allow real estate investors to defer their capital gains taxes as long as they roll the gain from the sale of one property into the purchase of a like-kind replacement property. With today’s sharp decline in commercial real estate values, their current property likely is worth less than what they paid for it.

If they sell their property, even if they don’t make money on the sale, they are going to trigger the capital gains taxes that were due from their previous sales. Selling at a loss does not eliminate those deferred taxes, according to Daniel Oschin, managing director of BGK-Integrated Group and president of BGK-Integrated Investment Services.

“Your taxes are never wiped out,” Oschin said.

It’s a situation that is likely to hit home with people who have traded properties over three, four or even five different legs of a 1031 exchange, re-leveraging them over the years and rolling significant gains into the property they’re currently holding.

What appears to be a loss, may in fact trigger taxable income, because of a low tax basis. This unfortunate situation can leave a real estate investor caught trying to find cash to pay Uncle Sam. (Jeff Brown details how this catastrophe was avoided here.)

Competent tax professionals are necessary for every real estate investor. A CPA or tax attorney should be contacted when considering a real estate investment decision.

925.385.8798

Using a 1031 Exchange to Upgrade Properties

A Tired Duplex in Concord

A Nicer Single-Family Home

Transaction Recap