If the first half of this year is any indication, 2017 promises to be another robust year for §1031 Tax Deferred Exchanges throughout the northeast. Rising real estate values, higher tax rates and new taxes implemented over the last few years have contributed to the rise of exchange transactions, as well as increased knowledge for property owners and their advisors.
As investors seek creative ways to preserve their equity and attain their property investment goals, proper guidance and planning becomes crucial. As a qualified intermediary (QI), IPX1031 is the key resource to the tax, legal and real estate communities, providing experience and knowledge in the 1031 arena.
Investment property owners from commercial to industrial, residential to retail, take advantage of the huge tax savings on capital gains and depreciation recapture tax by participating in a 1031 exchange. In fact this business strategy is used for selling both real property and personal property assets: Land and buildings, 30+ year leasehold and tenant-in-common interests, oil and gas royalties; business-use property assets such as machinery, manufacturing equipment, construction equipment, fishing vessels and charter boats, aircraft, trucks, artwork and collections, as well as intangibles such as distribution routes, franchise licenses, copyrights and patents.
All of the above and more are considered qualified property as long as they are exchanged for investment or income-producing property of “like kind.” Taxpayers selling multiple-asset property such as hotels, restaurants or gas stations often structure several exchanges to separately accommodate both the real property and personal property components.
Internal Revenue Code §1031 defines the QI’s main focus as a facilitator of the exchange portion of the taxpayer’s sale or purchase. However, much of the QI role takes place prior to the exchange itself. As a resource, we at IPX1031 participate in planning meetings, consulting with brokers, legal and tax advisors to map out a strategy for precision timing and maximum tax savings to meet clients’ investment goals.
When tax, legal and real estate professionals are brought in to analyze property and determine the right time to sell, a number of factors are taken into consideration. Are they looking to downsize or diversify their portfolio? How will the appreciation, depreciation and cash-flow affect the outcome? What will the tax consequences be for selling? These are all important drivers. Investigation and proper planning pave the way for a smooth transaction and accomplishment of the investor’s objectives.
Investor goals vary. Some are looking for ways to change or build upon their portfolios. Properties that have been stable investments are showing significant appreciation and equity. Since multiple properties can be acquired through a single tax deferred exchange, investors can diversify their real estate portfolio into multiple alternatives, thereby hedging the investment risk inherent in a single property. These replacement properties can offer greater income and long-term appreciation potential.
For others, it’s all about the taxes: In 2013 The Affordable Healthcare Act imposed a new 3.8% tax on certain investment income, including capital gains, for those with an adjusted gross income of over a certain threshold. Additionally, the American Taxpayer Relief Act raised the top long-term capital gains rate from 15% to 20% for those with higher taxable income. Both of these, combined with state capital gains tax and the Federal 25% Depreciation Recapture Tax, cause a substantial amount of equity to be due to the federal government at tax time. Consequently, 1031 exchanges are quite valuable to investors to preserve their equity!
For many exchanging is an estate planning tool: Investors want the income and benefits of ownership while they are alive, but want the property and hard-earned equity to pass on to their heirs upon death. When a taxpayer dies, the estate receives a stepped up basis in the inherited property. As a result, all of the built in gain disappears upon the taxpayer’s death. This taxpayer could have exchanged multiple times during their lifetime, leaving their heirs with a sizable benefit that would have otherwise been greatly reduced if the taxpayer had sold the property outright, paid the taxes and just given the remaining cash to the future heirs.
Arguably a 1031 exchange isn’t just beneficial for the taxpayer – it generates business for all those involved in the transaction: brokers, legal and tax counsel, financial institutions, ancillary services, etc. throughout a variety of industries including real estate, agriculture, manufacturing and equipment leasing. An understanding of section 1031 is essential to creating opportunities for advisors and their clients looking for options to reposition assets, generate more cash flow and protect estates. Rather than paying taxes, investors keep their equity working for them!
Patricia Flowers is vice president for Investment Property Exchange Services, Inc. (IPX1031), Boston, Mass.