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Flexibility is Key Among Benefits of Tax Deferred Exchange - 2007-03-24 |
For the past couple of weeks, we have explored the various forms of tax our
government collects on profits made by real estate investments.
One of the points I tried to make was that short term real estate "flippers"
are taxed at the highest possible rate, while "buy and hold" real estate is
never taxed until it is sold. Even then, there are major advantages to long
term investors over short term periods of ownership.
Last week, we looked specifically at depreciation, and how it provides a
small annual tax break for owners of residential real estate. This week, I
want to examine one final benefit of holding your real estate as a long term
investment, and that is the availability of the tax deferred exchange as an
alternative to selling.
If you remember, last week I stated that the only way to permanently beat
the tax man was to never sell or die, with your heirs finally inheriting the
property under a "stepped-up" basis. Well, that's technically true.
But if you are holding your real estate as an investment, meaning that your
original and continuing intention was and is to be a long term investor,
there is another option available if you want to sell your real estate. It
is outlined in the IRS code under section 1031, and it reads something like
this:
"In general, no gain or loss shall be recognized on the exchange of property
held for investment if such property is exchanged solely for property of
like kind which is to be held for investment."
And here's the bottom line: the ability to freely exchange property without
having to worry about paying taxes along the way is a tremendous benefit to
anyone who owns real estate. And it's only available to owners who have
opted for a long term strategy.
First, here are the rules in a nutshell:
* Any type of investment property qualifies for "like kind." So you can
exchange a rental house for a gas station, or you could exchange timber land
for an apartment complex. Only your residences and flipper houses are
disqualified.
* You can exchange many properties for just one, or you can exchange one for
many. There is no limit on number of properties or dollar amounts.
* There are strict time frames as to when you must identify the properties
involved and when you must complete all the purchases of replacement
property, but they are quite manageable, provided you plan ahead.
* At the conclusion of the transaction, you will ideally have no excess
cash, and no relief of debt. Any existence of cash or relief of debt will
not invalidate the exchange, but will simply invoke tax on the disqualified
amounts.
* During the period of the exchange itself, you can not touch or control the
proceeds of the sold property. Therefore, it is always best to use a
Qualified Intermediary to facilitate your exchange transaction.
Here are some reasons that the opportunity to exchange is so helpful to long
term investors:
* An exchange allows smaller investors to "trade up" without a tax penalty
to more expensive properties as his skill level and his financial capacity
allows.
A common path for real estate investors is to gain experience in residential
houses, then later move on into larger properties, and perhaps later venture
into commercial real estate. An exchange allows the investor to keep all his
equity at work instead of having large chunks drained off by taxation at
every transaction.
* An exchange allows the investor to consolidate his portfolio and
specialize in a certain type of project.
Without the exchange strategy, only super-wealthy individuals or groups
would be able to participate in larger projects. Exchanges allow small
investors to sell a number of smaller parcels and move forward into one,
perhaps more desirable project.
If an investor were required to pay significant taxes every time a sale
occurred, this would have a chilling effect on sales, thus making ownership
of investment property even more difficult and more exclusive. There would
be a tremendous disincentive to selling.
* At the same time, access to the exchange strategy allows mature investors
to implement a sensible exit strategy, trading active management duties for
the security of a monthly check.
One of the more popular recent developments in real estate investing is the
Tenant-In-Common shared ownership opportunity, more commonly called TIC
shares.
Let's say you have been an active landlord all your life and have built up
ownership in a small apartment complex and a small strip shopping center.
You have finally reached retirement age and are ready for less active
management, but you prefer not to see a large chunk of your ownership equity
evaporate in tax dollars when you sell.
Instead of selling for cash, you might exchange all your sale proceeds into
partial ownership of a Home Depot building, or maybe a building leased by
Kroger or Wal-Mart. These tenants often sign triple net leases for long
terms, such as ten or twenty years, and the tenant agrees to pay for all
costs of operation, including taxes, insurance, and all repairs.
The TIC share owners get a guaranteed check each month as their share of the ownership of the building, and because they exchanged from one form of real
estate into another, no tax is due when their previous property is sold.
The one word that best describes the benefits associated with exchanging is
flexibility. And that remarkable degree of flexibility is only available to
owners of property held for long term investment.
One final word: don't ever think on benefits such as the ability to exchange
or the right to take depreciation as tax loopholes. Instead, consider them
as incentives built into the tax code to encourage individual investors to
pool their funds and invest in their communities.
The IRS knows that the more money we make, the more it will collect in the
long run. Even the IRS knows a good investment is best left alone - at least
for a while.
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Tuesday, February 28th
Being a landlord can be a rewarding experience. It can also be a difficult one if you don't have the knowledge and understanding of what the process requires.
Few schools offer degrees in property management, so most landlords learn "on-the-job" through acquired knowledge and on-the-job experience, essentially re-inventing the wheel. This is an expensive and depressing way to learn anything.
Whether you're a full-time landlord or just getting ready to purchase your first rental property, whether you are a licensed Georgia real estate professional or an accidental landlord, this seminar will help you improve your property's value, increase your cash flow and decrease your expenses, from attracting (and retaining) good tenants to maintaining your property to understanding your rights and obligations under the law.
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PROPERTY TAX REDUCTION WORKSHOP
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Tuesday, March 27th
One of the significant annual expenses faced by any Georgia property owner is ad valorem property tax. Depending on where you live, it can be as high as three percent of the property's fair market value, and it must be paid year after year after year.
As a result, efforts to minimize this expense are not only worthwhile, they are encouraged by Georgia law. The phrase "ad valorem" means that each property is taxed based only on its value, and no one is required to pay a penny more than the minimum the law demands.
At the Property Tax Reduction Workshop, real estate expert John Adams will review the system he has used for over thirty years to reduce valuations and assessments in Georgia counties and municipalities, saving himself literally hundreds of thousands of dollars over the years.
In this 3 hour information packed seminar, John will teach you how to:
1. Understand the legal process of Property Tax Assessment
2. Meet the newly uniform Tax Deadlines
3. File your own Property Tax Return with a realistic valuation
4. Document your PT-50R with facts to support your case
5. Proactively meet with your Appraiser to reach an agreement
6. Protest your Notice of Assessment in an Intelligent manner
7. Give the Assessor an Opportunity to Save Face
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10. Take Your Case to Superior Court if necessary
If you are not doing all these steps now, you are likely costing yourself hundreds or thousands of dollars a year. If you own just one house, you could easily save over a thousand dollars over the next three years. If you own properties valued collectively over a million dollars, you are literally throwing away your profits year after year.
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