A Section 1031 Exchange is a transaction in which the owner of investment real estate is allowed to sell one property and purchase another without a tax consequence. Over the past few years, the use of this provision has expanded greatly due to the significant appreciation in real-estate values and awareness by more investors.
The primary advantage is that the investor has more cash to invest in the property that has been chosen as replacement property. This results in increased income and greater potential appreciation because the investor has more money working for him or her.
Another advantage is the ability to diversify investments into different property types and geographic locations. This has become much more prevalent over the last year or two with the emergence of the co-ownership format for owning investment real estate. In the tenant-in-common or "TIC" structure, investors are now able to complete an exchange by acquiring a fractional piece of a large property rather than owning the entire property. A TIC ownership interest is particularly attractive because the investment of cash can be matched to the needs of the investor and the properties are professionally managed, eliminating the hassles of being the landlord.
Exchanging often involves "trading up." This is the practice of using all of the cash received from the sale and the leverage of financing to increase the value of the replacement property well in excess of the value of the property that was sold. The use of leverage is considered by many investors to be the most valuable strategy in the exchange process because it provides a new basis for depreciation and may result in lower taxable income received from the property.By structuring successive exchange transactions over a period of years, investors can "grow" their money and the value of their real-estate holdings without being taxed each time a sale is made. Exchanges may be made as often as the investor wants, providing that each time a property is exchanged, the transaction is completed for its investment value and purpose.Another advantage, one often misunderstood or overlooked, is the ability to partially exchange a piece of investment real estate. This is referred to as receiving "boot." An investor may want to take out some of the equity (cash) in the property being sold and place it in a non-real-estate investment or just enjoy spending it. The investor determines how much cash will be taken out at the close of escrow on the sale and the remainder of the funds are moved forward to an exchange accommodator and ultimately into the replacement property. The result is a partial tax liability on the funds taken out and a deferral of tax on the balance of the funds that are reinvested.Daryl Templeton is a real-estate broker and consultant specializing in the structure of real-estate exchanges and tenant-in-common investment property fractional ownership plans. Source: The Santa Fe New Mexican. Powered by YellowBrix, Inc.