26A — March 15 - 28, 2013 — 1031 Exchange — Mid Atlantic Real Estate Journal


1031 E xchange

By Margo McDonnell, CES, 1031Corp. Pennsylvania version of a 1031 Exchange may be coming soon


ennsylvania Gov. Tom Corbett recently re- leased his budget for

the exchange of assets held for business use or investment. As you know, a 1031 ex- change is a strategy allowed under Internal Revenue Code section 1031. It allows taxpay- ers to defer the federal gain on the “exchange” of an asset held for business use or invest- ment. It involves the sale of a relinquished property followed by the acquisition of a replace- ment property from an unre- lated party within a 180-Day Exchange Period. Both trans- actions are linked together by a qualified intermediary (QI), such as 1031 CORP., and pertinent exchange documents. Any asset held for business use or investment can qualify but like-kind replacement property must be acquired. For example, investment real estate can be exchanged for other real estate

to be held for business use or investment. You can also exchange farm equipment for other farm equipment. Currently, income tax is due to the Commonwealth of Penn- sylvania for residents who complete a 1031 exchange and non-residents who exchange property that was located in Pennsylvania. There are a few exceptions (c-corps and when certain reporting methods are used) but in almost all situ- ations, the tax is due. While we are fortunate that Penn- sylvania income tax rates are lower than many other states, having this additional 3.07% to reinvest is great news for Pennsylvania exchangers! Gov. Corbett stated that he expects this new like-kind ex- change to be revenue neutral for the first three years and a

one of its boroughs or selling property located there will incur a local capital gain tax of 3.8%. Other localities may have similar local taxes which apply. 1031 Exchanges Help Investors Defer All Increased Capital Gain Despite these new tax in- creases, one aspect of the tax code still provides real estate investors with a huge tax advantage. Section 1031 allows property owners hold- ing property for investment purposes or use in a trade or business to defer taxes that would otherwise be recognized upon the sale of investment property. The ability to defer taxes applies to increased capital gain and the New 3.8% Medicare Surtax loss of $66 Million in tax rev- enue the following two years. A PA like-kind exchange provision is a win-win for the Commonwealth, its taxpayers and businesses as well as those completing 1031 exchanges. Just some of the many ben- efits For the Commonwealth and its Taxpayers: • JOBS! 1031 Exchanges help preserve and create jobs. Real estate professionals, lend- ers, closing officers, inspec- tors, attorneys, accountants and qualified intermediaries are just some of the parties involved in a 1031 exchange and its tax reporting. Once the replacement property is acquired, new owners usually do some work creating jobs for contractors, painters, suppli- ers, architects, landscapers, plumbers, electricians and lenders. • Keeps the economy moving forward. Rather than sitting on a property that no longer fits their needs but don’t want to sell because of the taxes, investors use an exchange to acquire something new – often trading up in property value. • Helps businesses grow which ultimately increases the taxes paid to the Com- monwealth. • Keeps taxpayers and busi- nesses in the Commonwealth rather than changing their primary residence or head-

taxes as well as the new 3.8% medicare tax. An ex- change provides a fantastic opportunity for investment property owners to defer all capital gain taxes that would otherwise be owed. Scott R. Saunders is se- nior vice president with Asset Preservation, Inc., a nationwide Qualified Intermediary and wholly owned subsidiary of Stew- art Title. PamelaA. Michaels is an attorney and vice presi- dent of Asset Preserva- tion, Inc. As a “Qualified Intermediary” as defined in the Section 1031 regula- tions, Asset Preservation, Inc. is not able to provide legal or tax advice. Accordingly, you should review the details of your specific transaction with your own legal or tax advisor. © 2013 Asset Preservation, Inc. All rights reserved. n quarters to another state to take advantage of their like- kind exchange provision. For Investors: • Keep equity invested in real estate or other assets held for business use or invest- ment • Opportunity to trade up into a property that would be otherwise unobtainable •Ability to diversify the type of property or location • Opportunity to create greater cash flow • Helps create an income stream during retirement For Business Owners and Farmers: • Opportunity to relocate to better location or expand into multiple locations • Ability to exchange older equipment for more efficient new equipment • Creates an exit strategy for business owners •Allows franchisees to trade up to more valuable fran- chises 1031 CORP. will keep you posted as we hear more but in the meantime, reach out to your state representatives and senators and let them know you support this initiative. Let them know how you or your clients have benefitted from a 1031 exchange. MargoMcDonnellis a Cer- tified Exchange Specialist andpresident of 1031CORP. in Collegeville, PA. n

t h e n e x t fi scal year and i t i n - cluded many broad-based b u s i n e s s tax reform i n i t i a t i ve s that cou l d i m p r o v e

Margo McDonnell

The following tables to the right, summarize a simple ex- ample in which the ROI from the two strategies is compared. In this case, New Property is acquired and held in an LLC by the QI while the Investor finds a buyer for the Old Prop- erty. During the three month exchange period, the Investor enjoys the rents from both properties. Naturally, the In- vestor has all the responsibil- ity for both properties as well as the income but the calcula- tions are done assuming that the rents are triple-net. As you can see, the dual rent income stream provided by a reverse exchange is vastly superior to the income from a delayed exchange even when the cost of the funds needed in advance 1 to acquire the New Property and the exchange fees are included. Why would any savvy Investor leave money of this magnitude “on the table” unless there was absolutely no other choice? These two advantages of re- verse exchanges – transaction control and ROI - are compel- ling in far more cases than has been taught or advertised in the past. Among the QIs still in business, there are only a few that provide genuinely state-of-the-art processes for reverse exchanges and fewer still that will eagerly engage with an Investor to determine their optimal strategy. Those that will engage in optimiza- Pennsylvania’s standing as a place to do business and spur economic growth. Also included was a proposal that had everyone at 1031 CORP. pretty excited – a Pennsylva- nia version of a 1031 exchange! PAhas long been one of the few states that does not recognize 1031 exchanges or have a similar provision to allow the deferral of state income tax on

Better backwards? The advantages of . . . continued from page 19A

continued from page 23A Perform a §1031 Exchanges to defer the new 3.8% Medicare Surtax Tax and . . .

tion of this nature are more than willing to admit that backwards may indeed be quite a bit better! Stan Freeman is pres- ident of The Exchange Strategies Corporation. 1 In a reverse exchange, the funds

needed to acquire the New Property have to be made available by the In- vestor through a combination of cash and credit. This does present a chal- lenge to some Investors but a close look at the benefits of this approach frequently stimulates a creative solu- tion. It should be noted that advance funds are typically replaced as soon as the Old Property is sold.

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