The case studies have been modified to protect the identify and all confidential information of transaction participants. The scenarios have been created based upon transactions and may contain elements from different 1031s. These examples are illustrative of the types of solutions Rexco1031 provides and may not match exactly with transactions that we have completed. They were written to give the reader an idea of how we can help creatively structure your 1031. These examples are not a guaranty of future performance or success of any investment.

 

Sell apartments, buy NNNs

Roberta and Richard owned a number of apartments in Santa Monica they acquired in the 1970s and 1980s. Roberta bought the first one, an 8-unit building acquired in 1979 for a purchase price of $210,000. Over the years, they spent a total of $75,000 on repairs, and had fully depreciated the property. The second one was purchased in 1983 for a price of $575,000, had 12 units and they spent a total of $90,000 on repairs over the years. Property #2 was also fully depreciated. Property #1 had a current value of $2,497,650 and Property #2, had a value current value of $2,875,000. Both of these are net of sales costs.

Here is a summary of the taxes due if they sold without a 1031.

 

The case studies have been modified to protect the identify and all confidential information of transaction participants. The scenarios have been created based upon transactions and may contain elements from different 1031s. These examples are illustrative of the types of solutions Rexco1031 provides and may not match exactly with transactions that we have completed. They were written to give the reader an idea of how we can help creatively structure your 1031. These examples are not a guaranty of future performance or success of any investment.

 

Sell apartments, buy DSTs

Georgia acquired a 30-unit apartment building in West Los Angeles in 1984 for $1,750,000. At the time she bought the building, she was concerned that values would stop going up as she had bought at the “top of the market”. Boy, was she wrong. The property had appreciated to a value of approximately $6,000,000 net of sales costs, was fully depreciated, and she had spent $365,782 over the years on a new roof, upgrading the units, new HVAC system, and other significant upgrades. If Georgia sold without the benefit of a 1031, she would have faced taxes totaling $2,140,001, or over 35% of her net sales proceeds.

Here is a summary of the taxes due if she sold without a 1031.

Georgia was also ready to move on from owning apartments. She always had a property manager, but had weekly issues and concerns throughout her ownership including multiple evictions, earthquake damage in 1992, lawsuits from tenants and recent restrictive rent control limitations. Georgia did very well, but she had enough and was ready to find a less management intensive real estate investment. One of her friends mentioned Delaware Statutory Trusts (DSTs), which are IRS 1031 approved structures where multiple parties get together and invest in a larger high quality real estate project. DSTs are formed, organized and managed by “sponsors”, many of whom regularly purchase and invest in high quality real estate assets around the country. These sponsors typically have vast commercial real estate experience because they are already investing on behalf of major pension funds and retirement investors like Fidelity and Vanguard. DSTs can accommodate up to 500 individual investors and pool their money to acquire larger assets where scale is important and provide access to institutional real estate for smaller individual investors. Georgia loved two main factors about his DST investment. First is diversification: Much of her net worth was tied up in one property in a single Southern California asset with risks such as earthquake, limitations of rent increases and an increasingly challenging business climate. Georgia was able to split her investment into multiple property types: apartments, storage units, and essential retail and also able to diversify by geographic location. Her net worth is now more fully diversified in Texas, North Carolina, and Tennessee, in different property types and industries, with three different sponsors. The second benefit for Georgia is allowing professional management to handle her properties. She no longer is responsible for the decisions made at the property level, leaving time for family, travel, and fun. The sponsors she chose all have a long track record of investment success, prudent management, and responsible investing.

In addition, Georgia’s rate of return went from 3.15% to 5.85%, freeing up her “trapped equity”. And while DSTs are illiquid by nature; that is, they are difficult to sell until the sponsor decides to sell, the advantage to this is that when the investment passes to her heirs someday, the kids will receive cash flow, but won’t be able sell the investment and go on a spending spree!!!!

The case studies have been modified to protect the identify and all confidential information of transaction participants. The scenarios have been created based upon transactions and may contain elements from different 1031s. These examples are illustrative of the types of solutions Rexco1031 provides and may not match exactly with transactions that we have completed. They were written to give the reader an idea of how we can help creatively structure your 1031. These examples are not a guaranty of future performance or success of any investment.

 

Sell four highly appreciated SFRs, buy Condo in a beach town and then later, convert to primary residence

Mary had acquired single family rentals for years and had a nice portfolio of properties near one of the largest universities in California. Because rental rates had not risen as fast as values, her return on equity was low and monthly cash flow was modest. We call this “trapped equity.” She began to ask herself if she was making the right decision to continue to own single-family rentals.

At the same time, Mary always hoped to retire someday in Southern California in one of the many beach towns in Orange County. She liked one community where homes often sell for between two and three million dollars.

The values of her properties, net of sales costs was $2.5 million, and she had total loans outstanding of $500,000. She had spent $165,000 on capital improvements over the years and had fully depreciated all the properties. Acquisition cost for all the homes was $1,250,000. If she sold now without the benefit of a 1031, she would owe approximately $705,767 in taxes. That’s over one-third (35.3%) of her equity!!

Here is a summary of the taxes due if she sold without a 1031.

The case studies have been modified to protect the identify and all confidential information of transaction participants. The scenarios have been created based upon transactions and may contain elements from different 1031s. These examples are illustrative of the types of solutions Rexco1031 provides and may not match exactly with transactions that we have completed. They were written to give the reader an idea of how we can help creatively structure your 1031. These examples are not a guaranty of future performance or success of any investment.

 

Using a reverse exchange to buy first

Sometimes it makes sense to do the upleg purchase first before you sell your appreciated property. This may be done when it is harder to purchase a property and relatively easy to sell the original one.

Robert owned a highly appreciated single family rental in a wealthy Northern California suburb of San Francisco. The market to sell was “hot” so it would be relatively easy to sell that property in a short period of time.

On the other hand, he was looking to purchase a NNN property in Texas and had a lot of requirements. He wanted a drug store tenant, with a long-term lease in excess of 15 years, a rate of return of more than 6.00%, and a location in a large city within one mile of a freeway exit. While these properties do come on the market occasionally, they often attract multiple offers and have an extremely competitive process to “win the bid”. Robert determined that he would be a much stronger buyer if he could eliminate uncertainty for the seller by making an offer with financing in place and not contingent on the sale of the property he wanted to sell, his downleg. This also mitigated the risk of the purchase of his upleg not closing within the required 1031 time limits.

Robert chose to buy first and then sell later, commonly called a “reverse exchange”. The process went well, he was selected over 10 other offers due to his clean contract and his quick speed to close with financing already in place. Once the offer to buy was accepted, he put his downleg property on the market, and received multiple offers. He closed on his “reverse exchange” purchase first, and then afterward completed the sale of the original property.

The case studies have been modified to protect the identify and all confidential information of transaction participants. The scenarios have been created based upon transactions and may contain elements from different 1031s. These examples are illustrative of the types of solutions Rexco1031 provides and may not match exactly with transactions that we have completed. They were written to give the reader an idea of how we can help creatively structure your 1031. These examples are not a guaranty of future performance or success of any investment.

 

Debt over Basis – Did you ever pull money out when refinancing?

Debt over basis occurs when the mortgage balance on your property is greater than the basis. That is, the cost of your property less all the depreciation you’ve taken, is less than your mortgage. This usually happens when you refinance the property a few times and take money out.

This was the case with Hector and Natasha who purchased an 8-unit building in the 1980’s for $1,798,000. After owning the property for several years, they refinanced and took out $500,000 to buy land for the new home they planned to build. They refinanced a couple of more times over the years each time pulling some cash out. In 2014 they refinance for $3,200,000 which seemed conservative at the time with the property appraising for $4,000,000. Now their property is worth $4,250,000 and they plan to sell. Over the years they have fully depreciated their property and the $280,000 they invested in improvements. Their loan was interest-only and they had a $3,200,000 balance to pay off. Their debt exceeds their adjusted basis. After paying off this mortgage with the $4,250,000 in proceeds, they had a tidy sum of $1,050,000 in equity. BUT… their tax obligation was $1,481,910. This means that after paying off everything, they had to give the government ALL of their $1,050,000 in equity plus come up with another $431,910 in cash to make the tax payment!

Hector and Natasha had to do a 1031 exchange to avoid this. They were able to invest in a DST and not only avoid the out-of-pocket $431,910 tax payment, but they preserved their equity, nearly doubled their cash flow, AND eliminated all the management headaches with their old apartment building which faced the need for a major renovation in the next couple of years.

The case studies have been modified to protect the identify and all confidential information of transaction participants. The scenarios have been created based upon transactions and may contain elements from different 1031s. These examples are illustrative of the types of solutions Rexco1031 provides and may not match exactly with transactions that we have completed. They were written to give the reader an idea of how we can help creatively structure your 1031. These examples are not a guaranty of future performance or success of any investment.

 

Sell primary residence using a 1031 exchange

Since the IRS only allows 1031 exchanges on real property held for business use, not personal use such as your home; it would normally not be allowed on the sale of a primary residence. But Jim and Marsha were able to use the 1031 exchange process and save millions in taxes by using the following plan.

Jim and Marsha bought a home in Brentwood for $750,000 in 1976 that today is worth over $8 million. If they sell the home now, they could take advantage of IRS code 121 which gives excludes taxes of up to $500,000 in gain, but they still faced a much larger tax bill on the remaining gain. They had spent $100,000 in improvements over the years which they could document.

However, the couple decided to move out of their long-time home and rent it out to tenants. It is not enough to declare the home as a rental, they must move out completely and then rent the property for a “period of time”. The IRS does not define “period of time”, but we have been advised that either one year, two tax returns, or 13 months of rental meets this standard.

Once the property appeared on Jim and Marsha’s tax returns as a rental and the “period of time” had elapsed, they were able to sell the highly appreciated asset and use the full benefits of the 1031 exchange.
One additional benefit of this structure is that Jim and Marsha were also allowed to take advantage of Section 121 of the Tax Code. Section 121 allows taxpayers to exclude up to $250,000 of gains on the income from the sale of a primary residence. Those filing jointly can exclude up to $500,000. Unlike the 1031 which is a tax deferment strategy, Section 121 reduces the taxes owed in the year of sale.

From J.K. Lasser’s Your Income Tax 2020: “If you sell your primary residence at a gain, up to $250,000 of the gain (and up to $500,000 for married couples) may be excluded from income if you owned and occupied it as a primary residence for an aggregate of at least two years in the five-year period ending on the date of sale.