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 Events: 9.24 Oakland Workshop and 10.7 SF Realtor Happy Hour!
Oakland Workshop: Please join Asset Exchange Company and the law offices of Bornstein & Bornstein for a free real estate workshop from 10:00am - Noon on Thursday, September 24th at the Oakland Association of REALTORS. To RSVP please call 877.471.1031 or email leonard@ax1031.com
SF Realtor Happy Hour: The San Francisco Real Estate Professionals Happy Hour Networking Event will be on October 7th at Nickie's Bar (466 Haight Street) in San Francisco from 5:30pm - 8:30pm. To RSVP or to join the Happy Hour Networking Group click here.
The Reverse 1031 Exchange
In a typical 1031 Exchange, a property is sold and then replacement property is acquired. On occasion however, it may be advantageous to do the opposite; acquire property first and then sell.
Acquiring replacement property first in a 1031 Exchange presents a few difficulties. First of all, funds will need to be available for the down payment on the acquisition property (keep in mind nothing has been sold yet).
Second, the properties involved in an exchange can not be owned at the same time. In theory, an exchange is going from one property to another – so title to the new property and the old property can not be held at the same time. Luckily however, there is an option available that allows for the acquisition of the replacement property first; it’s called the Reverse Exchange.
Here’s how it works:
To properly structure a reverse exchange, an Exchange Accommodating Title Holder, or EAT (your Exchange Company), will go on title to either the property being acquired (replacement) or the property to be sold (relinquished).
If the EAT is to go on title to the replacement property, problems may arise if the investor is financing part of the acquisition costs. Many lenders balk at the idea of an EAT going on title to the property the investor is acquiring.
The lender issues can be as follows:
- The loan will be made to the EAT not to the Exchanger.
- The EAT will require the loan to be non-recourse.
- The EAT will require the Lender to waive its due on sale clause for transfer of the new property from the EAT to the Exchanger.
- The EAT will require the Lender to waive its requirement that the EAT sign any warranties or representations concerning the new property.
- The EAT will require the Lender to allow junior or subordinate financing on the new property.
If the lender decides not to loan on the property because of the constraints previously stated, the investor has two choices: find a new lender or structure the exchange with the EAT taking title to the relinquished property that is ultimately to be sold as a straw buyer. Challenges with the EAT acting as straw buyer include:
- The EAT will require cash to buy the property. The cash must come from the exchanger.
- The amount of cash advanced by the investor is the amount of estimated equity in the relinquished property
- There may be a due on sale clause on the debt of the relinquished property.
- A property tax re-assessment may be made at the time title transfers
- The exchanger may be burdened with an additional county transfer tax
Despite the complications, the reverse exchange can be a powerful tool for the investor provided they are aware of the obstacles and have plenty of time to work through the challenges.
Cost Segregation: Accelerate Your Wealth Building
Every experienced real estate investor knows the importance of the annual depreciation deduction. Line 20 of Schedule E and the annual numbers entered on that line are valuable components of real estate investments. The value of depreciation is the cash component. Or rather, lack there of. Depreciation is a non-cash expense. Other allowable deductions on Schedule E are cash-based. You pay a plumber $200; you get a $200 deduction. Depreciation is different. Depreciation is better. Depreciation requires no cash outlays.
This article assumes the reader has a basic understanding of how depreciation works. The thesis of the article is how an investor can accelerate their annual depreciation deductions, thus taking full advantage of the time value of money. A dollar saved today is more valuable than a dollar saved tomorrow. The following analysis is how you can save that dollar today.
DEPRECIATION BASICS
Depreciation is the spreading of costs associated with acquiring an asset over the estimated economic useful life of the asset. Because land has an infinite useful life, it is not depreciable. So in order to determine annual depreciation deductions, a taxpayer must determine what percentage of their property’s value pertains to land. Once that is determined, the remaining value is the depreciable value. For example, if a property is acquired for $1,000,000 and the land is estimated to be 20% of the total, then $800,000 is depreciable.
The next step in determining annual depreciation deductions is determining the useful economic life of the property. For this, the government has provided the answer. Residential investment property is deemed to have a 27.5 year useful economic life and commercial investment property a 39 year life. In our example, if the property was residential in nature, we would divide $800,000 by 27.5 to get our annual depreciation deduction. The amount, $29,090, would be the amount entered into line 20 of Schedule E. The annual depreciation deduction reduces your taxable income, thus saving you money. An annual deduction of $29,090 can potentially save you up to $14,000, depending on your tax bracket and which state you live in.
ACCELERATED DEPRECIATION
Let’s all agree that a dollar saved today is better than a dollar saved tomorrow. Let’s also agree that deductions are dollars saved. So, how can we increase the dollars saved today? How can we increase our deduction amount to something above $29,090? The answer lies in the investment property itself and the government’s published schedule of useful economic lives. While true that residential real property is deemed to have a useful economic life of 27.5 years, all real property has components that are not considered to be real property for depreciation purposes. For example, certain fixtures in the property are considered to be personal property with shorter economic lives. Machines, telephones, lights, copper wires and microwave ovens all qualify as such. Such personal property is deemed to have 5 or 7 year lives by the government. Owner can accelerate their depreciation by dividing the depreciable amount by 5 or 7, rather than by 27.5. That creates more deductions and more dollars saved today. And a dollar saved today is better than a dollar saved tomorrow.
For example, let’s say our investor performs a cost segregation study and determines that instead of an annual deduction of $29,090, they can instead deduct $39,090. That is a reasonable expectation. The additional $10,000 deduction can save them perhaps $4,500 in taxes this year.
COST SEGREGATION STUDIES
In order to accelerate depreciation and save a dollar today, the IRS generally requires the owner to get a cost segregation study performed on their property. The study will determine the value of the property that can be depreciated in an accelerated manner. Without getting a proper cost segregation study, the risks of being audited and owing unnecessary taxes are much higher. Everyone wanting to accelerate their wealth building by accelerating their depreciation should plan a cost segregation study.
CONCLUSION
Real estate investors love their annual depreciation deductions. They only wish they could deduct more. Accelerated depreciation allows for increased deductions. Performing a cost segregation study is a necessary component in accelerating your depreciation, increasing your deductions and saving a dollar today, rather than tomorrow.
If you have any questions, or would like to schedule a consultation, please do not hesitate to contact Asset Exchange Company at 877.471.1031.
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9.24 Oakland Workshop
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Please join Asset Exchange Company and the law offices of Bornstein & Bornstein for a free real estate workshop from 10:00am - Noon on Thursday September 24th at the Oakland Association of REALTORS.
The workshop entitled, Marketing Tenant Occupied Properties, will cover topics such as:
- How to market tenant occupied and rent controlled properties.
- How to ensure cooperation from the tenant for inspections and open houses.
- When it is appropriate to offer a tenant 'cash for keys'.
- How to spot opportunities to increase your commissions while saving your clients thousands in tax payments.
- How seller financing can be used to increase the marketability of a property and also be used effectively in a 1031 Exchange.
- How investors are using the Reverse Exchange to help get their 1031 Exchanges completed in today's challenging market.
For further details and to RSVP please call (877) 471-1031 or email Leonard@ax1031.com.
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The
subject matter in this newsletter is intended as general information
only and not intended as tax or legal advice. Please always consult
your tax or legal advisor for any specific tax or legal matters.
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Asset Exchange Company offers :
*Competitive Rates and Fees ($499 to open an account)
*Free Audit Support
*Attorney/CPA
*Experience
*Integrity
*Custom Banking Solutions
*Individualized Solutions
Tel: 877-471-1031
Oakland Workshop
Date: Thursday, September 24th
Location: Oakland Association of REALTORS (directions)
Time: 10:00am - Noon
Topic: Marketing Tenant Occupied Properties
RSVP: Email or call 877-471-1031
GET YOUR LISTINGS NOTICED!
Brokers send us hundreds of great listings each month in the hopes of getting them in front of our 1031 Exchange clients.
In
an effort to streamline the process, Asset Exchange Company will be
sending out a regular email to our clients with some of these
listings. If you would like to submit your listing for consideration
please click here.
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