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Making Money in Real Estate
By: Bernard Bunning
1031's, REIT's & TIC's
In the current changing (or normalizing - depending on
your view) real estate market, the constant and
continual question remains: "How can I make money in
Real Estate?"
This is a viable question as real estate has proven to
be an extremely productive placement of investment
dollars over time. From my perspective, 1031 Exchanges,
REIT's and Tenants-In-Common replacement properties
offer tried and true money making methods. I'll describe
the basics of 1031 Exchanges for consideration.
Let's begin with "What is a 1031 Exchange?"
Section 1031 of the Internal Revenue Code has provided
that a real property owner who sells his property and
then reinvests the proceeds in ownership of like-kind
property is able to do so and defer any capital gains
tax. To qualify as a like-kind exchange, property
exchanges must be done in accordance with the rules set
forth in the tax code and treasury regulations.
What are benefits of a 1031 Exchange?
While the biggest advantage to entering a 1031 exchange
is to defer the tax burden, another advantage is
multigenerational. Based on current tax laws, after a
lifetime of tax deferral through exchanging, an investor
may leave the investment property to his or her heirs,
who will receive a stepped-up basis for the bequeathed
property, and not be taxed if it is sold at the
stepped-up basis (professional estate planning advice is
necessary to determine all factors and maximize the
benefits of this scenario).
What are qualification details of a 1031 Exchange?
In order to qualify, certain rules must be followed.
Broadly these rules are as follows: Both the
relinquished property and the replacement property must
be held either for investment or for productive use in a
trade or business. A personal residence cannot be
exchanged.
1. The asset must be of like kind. Real property must be
exchanged for real property.
2. The proceeds of the sale must be invested in a like
kind asset within 180 (property must be identified
within 45 days) days of the sale.
This exchange is an effective way to defer paying taxes
that would otherwise have been due on the first sale.
For example: an investor bought a commercial property, a
strip mall, for $200,000. After 5 years, he sells the
property for $450,000. This results in a gain of
$250,000 and the investor would have to pay capital
gains tax on this amount (subject to any depreciation
and recapture rules taxed at ordinary income rates).
However if he invests the $450,000 in another commercial
real estate (like kind - it does not have to be a strip
mall), he does not have to pay any taxes now - he defers
his taxes till a later date.
How is a 1031 Exchange is Accomplished?
Once an investor has decided to pursue a 1031 Exchange,
the process is fairly straightforward and will be
carefully facilitated by a Qualified intermediary. I
highly suggest that you contact a QI as soon as the
exchange decision has been made.
1. Investor decides to sell investment property and do
an exchange. Investor selects and contacts a Qualified
intermediary.
2. Investment property is put on the market.
3. Offer to purchase investment property is accepted.
4. Escrow for the sale is opened and preliminary title
report produced.
5. The QI sends required exchange documents to escrow
closer for signing at property closing.
6. Escrow closes.
7. Within the first 45 days after the close of escrow on
the sale of the relinquished property, investor
identifies replacement property as required by law.
8. Within 180 after the close of escrow on the sale of
the relinquished property, investor closes on
replacement property that was identified by them. The
exchange is completed.
What are potential challenges of a 1031 Exchange?
Frequently, the most difficult component of a 1031
Exchange is identifying replacement property within the
first 45 days following the sale of the relinquished
property. The IRS is very strict in not allowing
extensions.
What other Real Estate Invesment options are available?
This challenge of identifying 1031 replacement
property(ies) in the allotted time frame is where
Tenants-In-Common properties and Real Estate Investment
Trusts come into play.
Join me in my next column on "Making Money in Real
Estate" strategies where we'll continue to peruse these
other options.
Bernard Bunning, M.B.A, J.D., LL.M is the managing
partner of Bunning, Borst, Enfield & Klein located at
6939 Sunrise Blvd, Suite 120, Citrus Heights, CA 95660
(916) 728-1040
Writer Information
Written by
Bernard Bunning
Bernard Bunning, M.B.A, J.D., LL.M is the
managing partner of Bunning, Borst, Enfield
& Klein located at 6939 Sunrise Blvd, Suite
120, Citrus Heights, CA 95660 (916) 728-1040
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