10A — March 10 - 23, 2017 — Financial Digest — 1031 Exchange — M id A tlantic
Real Estate Journal
www.marejournal.com
1031 E xchange
By Jason Salmon, Kay Properties and Investments, LLC Why you should consider deferring your taxes
T he basics: If you own investment real es- tate—that means a
exchange, this provision allows a seller of property held for in- vestment or business purposes to “replace” their “relinquished” property in a “like-kind” ex- change. Implications of paying taxes: In certain cases, taxes on highly appreciated real estate in high-tax states can pack a pretty mean punch; potentially around 50%. This is comprised of taxes for long-term capital gains (up to 20%), depreciation recapture tax (25%), the net investment income tax (NIIT) that was embedded in the Af- fordable Care Act (3.8%), and
terms and content in the first part of this article may seem technical. Notwithstanding, if you own investment real estate, this is important. Your CPA and attorney will be fa- miliar with the jargon and with the subject matter. If they are not, find another CPA and/or attorney. Maximizing value: Many private real estate investors have a buy and hold approach; and this conventional wisdom is a sound strategy. If we look to the institutional real estate investment model (followed by university endowments, pen- sion funds, foreign governments and real estate investment trusts), the exit is a vital part of how a deal is underwritten. It is tremendously important to seek to sell an asset when opportunity presents itself. Having the ability to monetize your asset and get a potential premium in the marketplace makes sense, especially when a tool as valuable as the 1031 exchange can play a part in taking real estate investing to the next level. Options: There are several directions to go for real estate investors in a 1031 exchange. One way is to find an as- set with active management responsibilities—that means tenants, toilets and trash. If an investor wants a hands-on property with day-to-day land- lord responsibilities, this would be the appropriate way to go. Another is a passive real es- tate investment—a net-leased asset, specifically NNN (triple- net) real estate passes through taxes, insurance and property maintenance expenses to the tenant that occupies the prop- erty. These types of invest- ments can be attractive, but the investor must be sophisticated and understand the space (i.e., lease negotiations for renew- als, how inflation affects value, financing implications, etc.). There are also truly passive real estate investments that allow those in 1031 exchanges (as well as those wishing to make a direct cash invest- ment) to own a fractional in- terest in a large institutional asset or portfolio of assets. Utilizing this strategy allows an investor to diversify across multiple asset classes, geogra- phies and asset managers. The structure that is often used for this model is a Delaware Statutory Trust or DST. continued on page 12A
state tax (from 0-13.3% depend- ing on the state you live in). By the numbers: As an example, if you owned an in- vestment property valued at $1 million that was yielding an annual return of 5%, and when you sold the property and paid the taxes (let’s say 50% for illustrative purposes), you would have been left with only $500,000. You would have to go considerably higher up the risk-spectrum to receive a 10% return in order to receive the same $50,000 of projected in- come for the year. Many would say, that from a financial stand-
point, it is wise to exchange your property, defer your taxes and keep your full $1 million working for you. Death and taxes: In a 1031 exchange, the real estate basis is being carried forward. It will continue to do so with all subsequent exchanges. When a property owner passes away, their beneficiaries receive a stepped-up basis. This can prove to be quite advantageous when considering estate plan- ning as the capital gains taxes are eliminated. –Message to the reader– I realize that some of the
rental condo o r h o m e , a p a r t me n t bui lding , a commerc ial building, raw o r v a c a n t land or oth- erwise—you do not have
Jason Salmon
to pay taxes when you sell the property. Uncle Sam has had section 1031 of the Internal Revenue Code in place since 1921. Also known as a 1031
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