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4C — June 27 - July 10, 2014 — Mid-Year Review — 1 -( % 80%28-'
Real Estate Journal
1031 E XCHANGE S PECIALIST By Scott Saunders and Pamela Michaels, Esq., Asset Preservation, Inc. The perfect storm: “Three factors driving the surge in 1031 exchange activity in 2014”
I
n the movie The Perfect Storm, the convergence of two large storm systems
this year. Although real estate inves- tors are experiencing solid
Section 1031 of the Internal Revenue Code has emerged as a valuable tool for boosting net investment returns by reducing tax liability, and for preserving capital for reinvestment into better performing “like-kind” replacement properties. This article explores each of the three factors creating this “perfect storm.” FACTOR #1: HIGHER TAX RATES Many investors are surprised WRÀQGRXWWKDWWRGD\WKH\PD\ face four and, in the case of NY city residents or property own- ers five, different taxes and,
when combined together, the aggregate impact can result in a large tax bill owed to the
2. Federal Capital Gain Tax- es: Federal capital gain taxes are assessed on the remaining
led to unusual weather con- ditions that ultimately re- sulted in the demise of the ship and its crew. In the real estate market, the
gains, they are facedwith a headwind of high taxation which threat- HQVWRVLJQLÀ - cantly reduce investment returns, es- pecially in the
Pamela Michaels
Scott Saunders
convergence of much higher tax rates, a very strong commercial market, and a recovering resi- dential market has resulted in a surge in 1031 exchange activity
Northeast where state and local taxes are also factors. Conse- quently, investors are actively seeking out ways to reduce their tax liability. Once again,
government: 1. Depreciation Recapture: Depreciation recapture is taxed at 25% on all depreciation re- capture.
economic gain depending on an investor’s taxable income. Investors in the highest bracket pay at a 20% rate and a 15% capital gain tax rate applies to investors in a lower tax bracket. 3. Net Investment Income Tax: Pursuant to IRC Section 1411, an additional 3.8% sur- tax applies to taxpayers with “net investment income” who exceed certain threshold income amounts. 4. State Taxes: Investors must also pay the applicable state tax (which can be as high as 13.3%). 5. Local Taxes: Residents and property owners in NY city and the boroughs are subject to a local capital gain tax of 3.8%. The chart included demon- strates the various Federal Capital Gain rates applicable to capital gains depending on an investor’s adjusted gross income. FACTOR #2: ROBUST COMMERCIAL MARKETS Currently, commercial real estate (CRE) prices nationwide are about 3%above the previous market peak in 2006. Domestic commercial investors, institu- tions, and Real Estate Invest- ment Trusts (REITS) continue to exhibit a strong appetite for quality commercial properties. International investors see the U.S. as a safe haven, and their demand further fuels the CRE activity. Commercial investors have strong borrowing and buying capacity, allowing them to capitalize on favorable CRE opportunities. The demand for quality CRE assets is so strong that CRE activity is now begin- ning to expand to secondary and non-core markets. All of this CRE activity is contributing to the surge in 1031 exchange activity as CRE investors uti- lize 1031 to minimize the tax impacts of their transactions. Sales of office, retail, mul- tifamily, hospitality and land were approximately $370 billion last year, 18% higher than the year before, and the strongest continued on page 8C
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