How to Maximize Cash Flow With a 1031 Tax-Deferred Exchange

The World without 1031 Tax-Deferred Exchange

Let?s say you bought a residential property in the Bay Area for $200K fifteen years ago and financed it with a $160K loan. Since the property is located in a good area, its value has appreciated to $1M. Over the years, you refinanced the original loan to consolidate your other debts and currently owe $300K on the property. Each month, you collect $2,500 of rent. After paying $1,800/month for the loan, $350/month for property taxes and $55/month for insurance, you barely have any money left to pay for maintenance and other expenses.

As you grow older, you realize that you need a second source of reliable income; so, you are not completely dependent on your salary. Your company says its employees are its most valuable assets, but it also outsources many jobs to China and India to cut costs. You know you should not blame your company. It has to remain competitive. So when you see an attractive multi-tenant shopping strip in a middle-class suburb of Dallas, 100% NNN lease with $200K/year of Net Operating Income (income after all expenses except the mortgage payment) on the market for $2.6M, you get excited!

Since the residential real estate market in the Bay Area has softened, you consider selling your rental property to buy this shopping strip. You estimate that you would have to pay about $200K in federal and state income taxes on $800K of capital gain ($1M less $250K purchase price and selling fees, plus $50K in depreciation recapture). You just hate having to pay $200K to the government ? money that may go toward your down payment on the shopping strip. There is a better way ? a way to defer the income tax.

What is a 1031 Tax-Deferred Exchange?

Section 1031 of the Internal Revenue Code generally provides that neither gain nor loss is recognized if qualifying property is exchanged for other qualifying property of a like-kind. In the above scenario, you may defer the payment of $200K in both federal and state taxes if you acquire another investment property with equal or greater debt and equal or greater equity. In other words, if you buy another investment real property for $1M or more, using all of the net proceeds as down payment, then you may defer the $200K of taxes. Essentially, the government would lend $200K to you, without interest. And you may repeat this deferral and never pay income taxes.

How Do You Qualify for a 1031 Exchange?

You must comply with several strict rules. Failure to satisfy any of the rules will disqualify your transaction from a 1031 tax-deferred exchange.

1. You must trade up. The property you buy (replacement property) must have an equal or greater debt AND an equal or greater equity than the property you sell (relinquished property). This means you must put all of the net proceeds from the relinquished property to the replacement property and the fair market value (FMV) of the replacement property must be more than the FMV of the relinquished property.

2. The qualifying property must be of like-kind. The relinquished and replacement properties must be held for productive use in a trade or business or for investment, before and after the exchange. And one kind of property may not be exchanged for property of a different kind. For instance, you may not exchange a residential rental property for one you intend to occupy as your principal residence ? not qualifying property. And you may not exchange a factory for equipment ? not like kind. On the other hand, residential and commercial real properties are of like kind. So, you may exchange a residential rental property for a shopping center.

3. In a delayed exchange, you must identify the replacement property within 45 days and receive it within 180 days from the closing date of the relinquished property or by the due date of your tax return (with extension) whichever is sooner.

4. You may identify up to 3 replacement properties and must receive at least 1 of the 3. Alternatively, you may identify as many properties as you want as long as the total value of these properties does not exceed 200% of the value of the relinquished property.

5. You should have an exchange intermediary hold the sales proceeds of the relinquished property. Most investors use an exchange company as the qualified intermediary for a delayed 1031 exchange.

6. If you exchange a property with a related person (your children, parents), then both parties may not dispose the properties within 2 years.

7. If the sale proceeds are deposited in an interest bearing account during the exchange, you must receive the interests AFTER the close of escrow of the replacement property.

Strategies for a 1031 Exchange

The following strategies are intended for investors looking for commercial property as a replacement property.

1. Start looking for a replacement property early. Since you have only 45 days to identify replacement properties, you should make an offer as soon as the relinquished property is in escrow. By the time you close escrow on the relinquished property, you should have one offer accepted on a replacement property. This first choice does not need to be the most desirable property at the best price. You should think of it as a ?back-up? property. It is intended to take away your worries, such as ?Oh my God, what if I cannot find a replacement property??.

2. Identify more than 1 replacement property. If something unexpected comes up with your first choice, e.g. the soil is contaminated, you have a second and third choice to fall back on.

3. Specify a 30-day due diligence and cancellation period in the contract. This will give you more time to specify more than 1 property.

4. Think twice about choosing a replacement property with loan assumption. It?s much harder to get lender approval for loan assumption than for a new loan. Moreover, you have only once chance to get approval for loan assumption versus many chances to get a new loan approved. You don?t want to have your loan assumption denied by the lender after the 45 day identification period.

Questions for a 1031 Exchange Intermediary

Technically, you don?t need a 1031 exchange company to handle the exchange. However, it is advisable to have an expert assist you. This company will ensure that you comply with strict IRS rules. To decide which company to assist you, you should consider:

1. The fee is around $500-$750 per transaction. The company that charges less tends to limit you to 3 replacement properties and the company that charges more may not have that limit.

2. Whether your proceeds will be deposited in a separate trust account or commingled with the company?s main account. In the event that the company goes under, you don?t want your money stuck in that company?s account while the 45 day period expires.

3. Whether your proceeds will earn any interests and the money is insured.

What if you want to buy the replacement property first?

For some investors, the strict 45 day identification period and 180 day exchange period may be too short. The alternative is to consider a reverse exchange. It is a transaction in which the replacement property is owned by an intermediary party during the pendency of the like-kind exchange until the taxpayer is able to sell her relinquished property. Then the replacement property is exchanged to the taxpayer. A reverse delayed exchange is an advanced strategy, and you should consult a tax advisor to guide you.

The Happy Ending

Your offer of $2.5M for the shopping center is accepted. The bank lends you $1.875M at 6.5% interest amortized over 25 years. After paying $12,660/month for the mortgage, you still have $4,000 a month positive cash flow! Now you realize Uncle Sam is very smart. He allows you to have a tax-deferred exchange so you can maximize your profits. In return, he may collect more taxes later. And you are OK with that as both you and Uncle Sam win.

DISCLOSURE: To ensure compliance with requirements imposed by IRS Circular 230, we hereby inform you that the U.S. Federal tax advice contained in this article is not intended to be used nor has this article been written to be used, and it cannot be used, by any taxpayer for the purpose: (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. No tax advice is being given by this article for any specific transaction. If you desire advice about any particular transaction, then please consult a professional tax advisor.

David V. Tran is the CEO eFunding Inc., a commercial real estate brokerage, commercial loan broker, property management, self-directed IRA investment, TIC and syndication company in San Jose, CA. His website is http://www.efundingcom.com. He may be contacted at (408) 288-5500. eFunding does business in all 50 states. He is selected as Pensco Trust?s (a major self-directed IRA custodian) Preferred Professional. David is well-known for his 3 FREE real estate investment seminars:

1. How to invest in commercial real estate for retirement income NOW.
2. How to maximize cash flow with 1031 tax-deferred exchange.
3. TIC/Syndication: strategy for small investors and self-directed IRA investors to acquire high-valued properties.
   

   You are welcome to share this report, unedited and in its entirety, with anyone you like. You may not remove this text. ? 2007 eFunding, Inc.
   Andrew La is a real estate and tax attorney, CPA and Real Estate Broker in San Jose.

1031 Tax Deferred Exchanges - an Overview

Normally when investment property is sold, the IRS will tax any gain. The Federal Capital Gains rate is currently 15% and some states assess an additional tax as well. There is also 25% recapture rate on any depreciation taken over the length of ownership. Sellers not considering these factors can have serious tax consequences when selling investment properties. Section ?1031 of the Internal Revenue Code (IRC) provides an exception to these tax rules and is an important tool for any real estate investor.

Section ?1031 allows for deferment of the capital gains and recapture taxes, provided that certain rules and processes for exchanging are followed. This process is called a ?1031 Tax-Deferred Exchange or a ?Like-Kind? Exchange.

The Rules As mentioned, there are rules that must be followed to qualify for tax deferral using a ?1031 Exchange. A minimum of two properties must be involved in an exchange: one (or more) being sold, and one (or more) being purchased to replace it.

Not all properties qualify for an exchange: they must be held for productive use in trade or business or for investment. Qualifying properties can include rental properties, raw land, office space, and tenant in common properties. It is important to note that personal use properties, such as a primary residence, do not qualify.

The properties being exchanged do not need to be identical in nature, they just need to qualify as investment. So a piece of raw land can be exchanged for a condo, or an apartment complex could be exchanged for a Tenants in Common investment etc.

To defer all the capital gains tax, (1) the value of the replacement property must be equal to or greater than the sale?s property, and (2) all of the sales equity (cash remaining) must be reinvested. A ?1031 Exchange can still be used even if all the money will not be reinvested. Any money that is included in the exchange and used to purchase replacement property will be tax deferred and any remaining amount will be taxed. This is called a partially deferred exchange.

The most important requirement for a successful exchange is that an independent third party- called an Accommodator or Qualified Intermediary must be used. If a property is sold without a Qualified Intermediary and the proceeds are given to the seller, the IRS will assess the capital gains tax and the opportunity to defer will be lost. In a ?1031 Exchange however, the proceeds are forwarded to the QI who holds them until the client directs their use to purchase replacement property.

There are three critical timing rules. An exchange must be entered into prior to the close of the sales property so it is very important to contact the QI early on. Within 45 days of the close of sale, potential replacement property must be identified in writing with the accommodator. And within 180 days from closing of the sale, all replacement property must be purchased.

By following these guidelines with the help of a 1031 Specialist, investors have the opportunity to build wealth by reinvesting undiminished gains into their next property.

To talk with a 1031 Exchange Expert or call 866-405-1031

Investment Properties - 1031 Exchanges

If you are selling an investment property and planning on re-investing then the 1031 exchange is right up your alley. A 1031 exchange is basically a tax shelter allowed by the IRS where you sell an investment property and then re-invest the profit from that sale into another property. Now, keep in mind that you must re-invest the entire amount from the sale. This is not to say it has to be in one property, as long as you re-invest the full amount it does not matter if it is spread amongst several properties. In doing the exchange, an intermediary or third party, usually a company or financier will hold the funds from the sale until a"like-property" is found whereupon the funds will be released to complete the sale.

From the time that you sell your investment property you then have 45 days to identify the property or properties that you intend to purchase with the proceeds. There are also a few safeguards built into the process to ensure that it is not abused. One of these is called the 95% Exception rule. This rule states that you must acquire 95% of the property that you declare an intent to purchase or "identify." Another guideline is the fact that once your sale property closes, you have six months from that date to close on your identified properties.

Almost any kind of property qualifies for a 1031 exchange except for your primary residence. This makes the 1031 exchange a great opportunity for beginning investors to make their mark on the investment market. For complete information on 1031 exchanges it's a good idea to check the IRS web page which features complete and comprehensive information on everything that is involved with this type of financial transaction. There is also a healthy selection of companies that operate as the financial intermediary that can provide accurate info for the investor.

Frankie Bastek is a professional and experienced Realtor? spaecializing in the Orange County area. For the best service and advice concerning Laguna Niguel real estate, check out http://www.homefindings.com

Types and Features of 1031 Reverse Exchanges

A reverse exchange occurs when the taxpayer intends to make a like-kind exchange but, for some reason, acquires the replacement property before selling the relinquished property. The taxpayer may fear that replacement property vital to his business will be sold to another party.

Perhaps the reverse exchange is the result of the buyer backing out of a previously arranged simultaneous exchange or the seller forcing a premature closing on the replacement property. In any event, the taxpayer completes the replacement leg of the exchange first.

This is accomplished by using the buyer of the relinquished property or an outside party, known as an accommodator or intermediary, to purchase and hold title to the replacement property. At a later date in a separate transaction, the relinquished property is transferred to the buyer and the taxpayer receives the replacement property.

The taxpayer typically provides a loan to the accommodator to fund the down payment on the replacement property. The property is usually financed with an assumable mortgage. When the taxpayer receives the replacement property, he assumes the mortgage.

There are three types of reverse exchanges:

* Type 1: "Reverse regs." exchange.

* Type 2: "Biggs"(9) reverse exchange.

* Type 3: "Simple" reverse exchange.

The first two types rely on an accommodator or intermediary who is hired to complete the exchange. The first transaction under these two approaches is the same. It is the separation in time between the first and second transaction that creates the deferred exchange.

The transactions for the "reverse regs." exchange (Type 1) are:

* First transaction: The accommodator acquires the replacement property from the seller. The accommodator holds title to the replacement property while the taxpayer seeks a buyer for his relinquished property.

* Second transaction: At a later date, after identifying the buyer, the accommodator exchanges the replacement property for the taxpayer's relinquished property. The accommodator immediately sells the relinquished property to the buyer.

Using a "Biggs" reverse exchange (Type 2), the second transaction becomes:

* Second transaction: At a later date, the buyer purchases the replacement property from the accommodator. The buyer then exchanges the replacement property for the taxpayer's relinquished property.

A reverse exchange can also be affected without an accommodator. In a "simple" reverse exchange (Type 3), the buyer serves a dual role, facilitating the transactions for the taxpayer and purchasing the relinquished property. A "simple" reverse is the rarest of the three types of reverse exchanges. It will most likely be the result of a simultaneous exchange that has unraveled.

Reggie owns and operates http://www.1031tax.us and knows how to to avoid the mental confusion associated with 1031s and savings through deferred exchanges.

When is a Reverse 1031 Exchange the Right Choice?

Tax-deferred exchanges are great opportunities for real estate investors. In a typical property transaction, the seller is hit with the capital gains tax. Fortunately, section 1031 of IRS code stipulates that no gain or loss will be recognized in a qualifying exchange. A tax-deferred exchange is not as simple as swapping properties though. There are specific deadlines the exchanger must meet in order to reap the tax benefits. Once the first property is relinquished, the replacement must be identified within 45 days and closed on within 180 days. If this schedule in not met, the exchanger stands to lose all the deferred benefits of the 1031 code. In the right context, a traditional 1031 can be ideal. In other situations, investors may benefit from more specialized types of exchanges. The investor who finds a new property before selling the like-asset will need something more advanced than a conventional exchange. This sort of investor should consider a 1031 reverse exchange.

There are many advantages to a reverse exchange, but the most obvious is that a property owner can find a replacement like-asset without time constraints. Controlling a replacement property in advance of selling the initial asset alleviates much of the pressure involved in a traditional exchange. A reverse exchange is an appropriate option for the investor who is ready to purchase a new building but has not yet sold the initial property of the exchange. In essence, a reverse 1031 avoids the risk of having to pay substantial capital gains taxes on a sale should an exchange property not be purchased in time.

However, a reverse exchange is not entirely without defined deadlines. The schedule for a reverse exchange is identical to that of a traditional exchange, except the relinquished asset and replacement asset trade roles. In a reverse 1031, the relinquished property must be identified within 45 days of purchasing the replacement. In addition, the relinquished property must actually be relinquished within 180 days.

The 1031 code can be hugely advantageous for investors. The tax saving are, in effect, like a 0% interest loan from the federal government that extends indefinitely. Many options and variations exist for exchangers looking for a tax-deferred benefit. But for the investor who has found a replacement property prior to selling anything from his or her portfolio, the reverse 1031 exchange is the clear choice.

Information from this article taken from http://www.allstates1031.com/

Christine Casalini is a freelance writer in Boston, MA. Her interests are investing, real estate and personal finance

1031 Exchange ? The Most Common Mistakes!

A property transaction related to a 1031 exchange into a Tenant in Common property could have a great impact on the financial stability of a person. Any mistake or a wrong decision in regards to a 1031 exchange can put you in deep trouble, besides unexpected financial liabilities.

It is often seen that most people interested for a 1031 exchange into a Tenant in Common property commit certain basic mistakes that jeopardize the whole transaction or results in a complicated legal situation leading to the client paying a huge tax or penalty amount.

Before I tell you about these common mistakes, let me first explain in brief what is 1031 exchange and how it helps.

Section 1031 of the IRC gives a chance to real estate buyers to defer the capital gain taxes that they incur by selling a property. It states, a real property owner can sell his property and then reinvest the proceeds to purchase of like-kind property and defer the capital gain taxes. Like-kind exchange is considered as one of the best-kept secrets of the Internal Revenue Code and very few CPAs, lawyers and financial advisors have proper knowledge about this.

By doing a 1031 exchange into a Tenants in Common (TIC) property, you can become a part owner of a large commercial property managed by professionals, who pay you a monthly income for the property. This is favorable for most people because it has got fewer strings attached compared to private annuity trusts, charitable trusts etc.

There are 3 Major mistakes that are generally committed by people going for a 1031 exchange into a Tenant in Common property.

a) Ensure that your investment company has their act together. Ask them for their history in TIC offerings, check referrals for satisfied clients. A good and experienced investment company should be able to provide you with multiple references of satisfied clients. Also check the properties available with them, a good investment property would only pick the best properties ? good real estate properties are hard to find and sells fast. While mediocre or small investment companies will deal with B grade or less desirable properties, the good investment firms will have only the best properties on offer.

If you are planning to do it privately, be cautious about getting into a Limited Partnership where only one or two members make all the decisions. Another alternative to could be to get a group of friends together and do it all by yourself, however, that is feasible only if you have extensive experience with commercial property and property management.

b) Choose a well-experienced qualified intermediary. A qualified intermediary is extremely instrumental in the successful completion of a 1031 exchange for Tenants in common property. They need to be well conversant with 1031 exchange rules. They ensure that all documentation and money transfer meets the guidelines set for the by section 1031 of the IRS.

Your Accommodators will set up your LLC. It is suggested that you should not work with an accommodator with whom you have an existing relationship. Your family attorney or estate planning attorney may not qualify as your accommodator. A small mistake here can lead to a hefty bill for taxes or penalties by the IRS, or even worse, the whole transaction might fail due to the incompetence of your accommodator or qualified intermediary.

c) Don?t try to cut corners on your property management company. This is extremely important for profitable performance of your investment. You will have to depend on your property management company for the day-to-day problems that will arise; they will be responsible for paying your property taxes in time and maintaining your building. Your property management company should be able to offer you a long term Triple Net Lease that has detailing of your annual income percentage along with scheduled increase. Only reputable management companies would be in a position to offer this. It is worth spending on a good property management company as you get a much higher return on your investment with them compared to any startup. Let your management company have a small profit because their performance is directly related to your investment stability and is going to get you multiples of that amount.

If you are hiring an experienced property management firm it is always a win-win situation of both the parties and you are sure to make the best out of your investment.

Avoid these common mistakes while planning your investment for 1031 exchange into Tenant in Common properties and you can ensure a continuous flow of monthly income while your investment experience a steady growth.

This article is written by Ray Smith, a marketing expert with years of experience in different industries and specialized knowledge on branding and Internet marketing. http://www.1031assistance.com

1031 Exchange

The 1031 Exchange, from the Internal Revenue Code Section 1.1031 is a code that can end up saving individuals money on certain business and investment property transactions.

The 1031 Exchange allows sellers of some real estate and personal property to be exempt from paying the capital gains taxes if they are ?exchanging? the property they sell for a new property of ?like-kind?. This code only applies to business property and investment property, not purely residential property.

An example would be selling a property used as an office for a business and buying a similar property that will be used as an office instead. Any profit made on the sale will not be taxed because it is to be used towards the purchase of the new property. The newly purchased property doesn?t necessarily have to be the same type and size, but it has to be used for the business or investment purposes. Similarly, a property purchased for investment purposes can be sold to buy a different property for investment purposes, without taxing the profit. The broad definition of exchanging for a ?like-kind? property allows for some flexibility.

There are further factors to be considered involved in the 1031 code. The purchase of the new property must take place within 180 calendar days of the sale of the original property. This gives individuals time to work out all of the details involved in purchasing and selling real estate. It is often more financially efficient to make the sale and purchase as close in time as possible. The 1031 code requires a qualified intermediary after 45 days of the sale to ensure that the gains are used towards the purchase of the new property. This prevents individuals from using the profit for their financial gain. Qualified intermediaries, however, charge fees for each exchange and additional properties.

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Check with Steve Cross in Las Vegas who is an expert in this area of Real Estate