Posts

REALTORS Land Institute 1031 Exchanges

An Alternative to the 1031 Like-Kind Tax Exchange

It was a brutally cold, windy and overcast morning in the Dakotas Territory. The year was 1871. Every living creature exhaling air was immediately turned into vapor from the freezing temperatures. We were soldiers in the 7th United States Calvary Regiment and this particular morning, we were not singing “Garyowens”. Thousands of settlers were flocking to the territory and our job was to protect them. At this moment, many of the settlers were being threatened by the bad guys and we were preparing to ride to their rescue.

Commanding F Company was the American icon Capt. John Wayne. His Second in Command was WWII hero Lt. James Stewart. Work with me here. We were divided into two wings. One the left wing, 1st Squad was manned by the great Virginian Sgt. Randolph Scott and 2nd Squad was led by the incomparable Sgt. Errol Flynn.

The right wing was led by the 3rd Squad’s fearless Sargent Glenn Ford, who later helped defeat the Japanese Navy at the Battle of Midway, and the 4th Squad was led by Yours Truly right out of “The Point.” Again, work with me. The battle lines were drawn and we were ready for action. Captain Wayne gave the order and the bugler belted out the Calvary charge. The horses leaped into action, our swords at the ready and at that very moment….my alarm went off and it was a Wednesday morning in 2015. Another missed opportunity to ride to the rescue. Or was it?

Scrutiny Looms Over Section 1031s

Section 1031 is beginning to receive scrutiny by Congress and that’s probably not a good thing. All of the appropriate organizations including the Institute are lobbying Congress to leave 1031 exchanges alone–and for all the right reasons. But this is Congress, and that means that this will probably become a huge political football. I have no inside information but based on being in practice since the late 70s, my gut feeling is that 1031 exchanges will be modified to some extent. Perhaps, the first 500k in capital gains can be passed on to a new replacement property or something along those lines may be the final result.

Can You Help Your Clients Without Using 1031s? Yes!

So, assuming that Section 1031 is changed in some fashion, how can Institute members ride to the rescue to still help their clients defer capital gains taxes, state taxes where applicable, depreciation recapture, the Obama care tax and possibly the alternative minimum tax when selling a clients’ property. Actually, there are options now and you don’t even need a 1031 to defer taxes. Let’s turn a negative into a positive.

Imagine not having to deal with a forty-five day identification time limitation or loan to value ratios. What if you could sell a client’s great property now, defer taxes and at any time in the future, you can buy any property that you would like for your client AND while you are looking for that property, your client can receive a check every month for roughly five to six percent of the sales proceeds while those proceeds are still tax deferred. Do you think that this might give you a competitive advantage over other brokers that are unable to provide this opportunity?

Imagine working and taking constant risks for thirty or forty years or more and when you’re finally ready to retire, you have to write a check for twenty-five to thirty percent of your liquid assets to the US Treasury before you can retire. Well, fortunately you don’t have to but when selling your clients properties, they do have to write a check to the US Treasury for twenty-five to thirty percent of their sales proceeds and for many, that’s THEIR retirement plan. You can still defer those taxes for your clients and keep more of their hard earned sales proceeds in their pocket and send less to Washington, even if a 1031 isn’t appropriate. Do you think that this might give you a competitive advantage over other brokers that are unable to provide this opportunity?

Another tax deferral strategy that might face Congressional scrutiny in the future is the stepped up basis. I have met a number of older land owners who intend to pass their property on to their heirs instead of selling their property because of the large tax liability that the sale will create, and because a 1031 isn’t appropriate. That’s not necessarily a bad strategy unless you make a living selling real estate.  If you do sell real estate, it is possible for the land owner to sell their property and defer taxes and turn an illiquid asset into a lifetime retirement income. When the land owner passes on, the income can be passed on to the heirs. And you just sold a great property.

The great thing about the REALTORS® Land Institute is the sharing of ideas and strategies and that’s why Institute members and Accredited Land Consultants (ALCs) tend to be more successful and have higher incomes than non-members I certainly hope that Congress doesn’t make changes to Section 1031 but if they do, we can still ride to the rescue of our clients without having to be John Wayne or….even me. Let’s turn a potential negative into a positive today by recognizing there are other ways to defer our clients’ taxes than a 1031. You will sell more real estate and keep more of your clients’ hard earned sales proceeds in their pockets and sending less to Washington. Happy selling and deferring taxes!

David Fisher, Creative Real Estate Strategies

David is a Partner at Creative Real Estate Strategies, a 2015 Silver Partner of the Institute, and has been in the industry since the late 70s. His years of experience help him to assist land brokers in helping their clients defer capital gains tax, state tax and depreciation recapture taxes on their client’s sales proceeds when either their clients are unable to complete their 1031 or the client would like to sell and retire but still defer taxes. By understanding these tax deferral strategies, brokers have been able to sell more real estate. David can be reached at 713-702-6401 or at David@cresknowsrealestate.com

Section 1031 Exchanges are Important to a Healthy Economy

Over the past two years there have been numerous proposals to restrict or eliminate I.R.C. §1031 tax deferred exchanges. These proposals are based on misunderstandings about §1031 and do not account for the powerful stimulus impact that §1031 exchanges have on the US economy. This article will debunk a few of those myths and discuss the findings of a couple of recently released studies that quantify just how important §1031 exchanges are to a healthy US economy.

Myth: Section 1031 allows taxpayers to avoid capital gains taxes, and to defer gain indefinitely.

Truth: Under §1031, taxes are deferred—not eliminated. Section 1031 exchanges structured under the IRS regulatory safe harbors are neither tax savings vehicles nor “abusive tax avoidance schemes.” Payment of tax occurs: 1) upon sale of the replacement asset and 2) incrementally, through increased income tax due to reduced depreciation deductions. A recently conducted study entitled “The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate” conducted by Professors David Ling and Milena Petrova (“Ling & Petrova Study”) examined more than 1.6 million commercial real estate transactions between 1997 and 2014. It found that nearly eighty-eight percent of properties acquired in a 1031 exchange were ultimately sold in a taxable sale, rather than a subsequent exchange.

Myth: The absence of a precise definition of “like-kind” is administratively difficult for the IRS and creates the opportunity for abuse.

Truth: The definition of “like-kind” is well understood, §1031 is neither administratively difficult nor abusive. Like-kind exchanges facilitated by professional Qualified Intermediaries, and conducted within the regulatory safe harbors, are straight-forward transactions that follow a well-understood set of rules (including definitions), procedures and documents.

Myth: Like-kind exchanges are used only by the wealthy.

Truth: Like-kind exchanges are used by a broad spectrum of taxpayers at all levels.Section 1031 is fair, benefitting taxpayers of all sizes, in all lines of business, including individuals, partnerships, limited liability companies, and corporations. A 2011 industry survey concluded that sixty percent of exchanges involved properties worth less than one million dollars, and more than a third were worth less than five-hundred thousand dollars. Exchanged properties include real estate, construction and agricultural equipment, railcars, vehicles, ships and other investment and business-use assets.

Myth: Elimination of §1031 like-kind exchanges will raise significant revenue.

Truth: Elimination of §1031 would result in a long-term reduction in Gross Domestic Product (“GDP”) of the US. Section 1031 is a powerful economic stimulator, encouraging investment in small and medium sized growing businesses, thereby promoting US job growth. Section 1031 exchanges contribute to the velocity of the economy by stimulating a broad spectrum of transactions ancillary to the actual exchange which, in turn, generate jobs and taxable income through business profits, wages, commissions, insurance premiums, financial services, and discretionary spending by gainfully employed workers. This transactional activity raises state, local and federal tax revenue through transfer, sales and use taxes and increased property taxes.

Ernst & Young recently released a macro-economic study, Economic Impact of Repealing Like-Kind Exchange Rules, that found that the U.S. economy would contract by approximately $61 – $131 billion over ten years if §1031 was eliminated.

Other key findings of the Ernst & Young and Ling & Petrova studies included:

Like-kind exchanges encourage capital investment. On average, taxpayers purchased replacement property that was approximately thirty-three percent more valuable than their relinquished property;

Elimination would increase the cost of capital and slow the velocity of investment;

Like-kind exchanges contribute significant federal tax revenue. Thirty-four percent of exchanges were only partially tax deferred; some federal tax was paid in the year of the exchange. Additionally, eighty-eight percent of replacement properties are eventually sold in taxable sales rather than in a subsequent exchange, resulting in higher taxes paid due to increased capital investment. Elimination would result in less federal revenue.

Like-kind exchanges create jobs. Real estate acquired through a like-kind exchange is associated with greater investment and capital expenditures (job creating property improvements) than properties acquired without the use of a like-kind exchange.

Elimination of §1031 would impact the overall economy, with an unfair concentration in certain industries including real estate, construction and equipment manufacturing and leasing.

The complete Ernst & Young and Ling & Petrova studies can be found at:http://www.ipx1031.com/wp-content/uploads/2015/03/EY-1031-Economic-Study-3-2015.pdf and http://www.ipx1031.com/wp-content/uploads/2015/07/Ling-Petrova-Economic-Impact-of-Repealing-or-Limiting-Section-1031.pdf.

Both studies quantify that like-kind exchanges are important to a healthy economy. They increase transactional activity, provide an incentive to improve properties and increase investment in the US. Make sure your elected representatives know the facts. Click hereto send them a letter telling them that §1031 is important to you and your livelihood.

Assistant General Counsel for IPX1031®

Contributor James Miller, Assistant General Counsel, IPX1031®

Jim Miller is the Assistant General Counsel for IPX1031® a Qualified Intermediary, a national leader in §1031 tax-deferred exchange transactions and a wholly owned subsidiary of Fidelity National Financial. He is an approved LANDU instructor for the “Tax Deferred 1031 Exchanges” course, “Advanced Tax Deferred 1031 Exchanges for Land Professionals” course and helped author the ALC Exam and the “ALC Core Course Manual.” Miller can be reached at 602-850-8630 or at james.miller@ipx1031.com. To reach your closest IPX1031® office, call 888-771-1031 or visit www.ipx1031.com.

This piece was published in the 2016 Fall Terra Firma publication.