<p><span><span><span>Like-kind exchanges provide benefits to sellers of agricultural property under <a href="https://www.accruit.com/property-owners/1031-exchange-explained&quot; title="Start an Exchange with Accruit">Internal Revenue Code Section 1031</a>. Section 1031 helps preserve the sellers’ agricultural assets, such as farmland and ranches, utilized for productive use in a trade, investment, or business purposes, when the seller exchanges their property for a “like-kind” property. “Like-Kind” property can be defined as any real property used for trade, investment, or business purposes. In broadest terms, Section 1031 gives sellers the right to exchange business or investment real estate to purchase other business or investment real estate. There is often misunderstanding when it comes to “Like-kind” property as “like-kind” does <u>not</u> mean the same type of property as the property being sold<i>.</i> </span></span></span></p>

<p><span><span><span>This common misconception people have when selling agricultural property is that you must buy agricultural property in a <a href="https://www.accruit.com/blog/1031-real-estate-exchanges-what-like-kind&…; title="1031 like-kind exchange">1031 like-kind exchange</a>. The fact is you can buy any real property such as farm, ranch, apartment complex, commercial building, or rental home used for trade, investment, or businesses purposes. These rules allow agricultural property owners to diversify their investments and grow a wider range of assets. Without 1031 tax deferred exchange, agricultural property owners will be held responsible for paying taxes on the property being sold, even if they reinvest and purchase new property.</span></span></span></p>

<h2><span><span><span><b>What can Agricultural Property Owners Exchange with 1031?</b></span></span></span></h2>

<p><span><span><span>Agricultural property owners can exchange labor, chemical, and water intensive land into less management intensive property such as residential or office condominiums. Or they can exchange conservation easements on their ranch land to acquire new property. </span></span></span></p>

<div class="accruit_dark_blue_color"><span><span><span><i>For example:</i></span></span></span></div>

<div class="accruit_dark_blue_color"><span><span><span><i>Recently a client sold two easements on his agricultural land. One of the easements restricted his ability to use the wells on his land. This helps keep water in the underground aquifers and permits more water to flow further downstream for other users. The second easement restricted his ability to use chemical fertilizers on his land. The societal benefit here is that fewer chemicals being applied to the land mean fewer chemicals running into the streams, polluted the water, and killing the fish. The cash generated by the sale of the easements was used to acquire a few single-family homes nearby, which will be used as VRBO/Airbnb&nbsp;type rentals.</i></span></span></span></div>

<div class="accruit_dark_blue_color">&nbsp;</div>

<h2><span><span><span><b>Time is of the essence when it comes to Selling and Obtaining Real Property</b></span></span></span></h2>

<p><span><span><span>Timing is crucial when it comes to selling and acquiring real property in a <a href="https://www.accruit.com/blog/primer-1031-exchanges-and-related-types-ex…; title="1031 tax deferred exchange">1031 tax deferred exchange</a>. As property owner, you will need to contact a qualified intermediary, like Accruit, to process a 1031 tax deferred exchange. Without doing so, you may miss out on an opportunity to invest while you are waiting on your current property to sell. <a href="https://www.accruit.com/blog/tax-code-sections-1031-and-1033-whats-diff…; title="section 1031 like-kind exchange">Section 1031</a> gives the seller 180-days to replace their property when exchanging into another real property. </span></span></span></p>

<h2><span><span><span><b>Why am I doing a 1031 tax deferred exchange?</b></span></span></span></h2>

<ul>
<li><span><span><span>Diversify your portfolio</span></span></span>

<ul>
<li><span><span><span>Rather than having all of your funds locked into one large property, you can reinvest into multiple properties of different asset classes (residential, commercial, retail, etc.).</span></span></span></li>
<li><span><span><span>Rather than having all of your funds locked into one location, you can reinvest across town, or across the country, to take advantage of stronger opportunities. </span></span></span></li>
<li><span><span><span>Spread assets into smaller investments as party of an estate plan.</span></span></span></li>
</ul>
</li>
<li><span><span><span>Upgrade or consolidate your portfolio</span></span></span>
<ul>
<li><span><span><span>Rather than having your investments scattered across the county, consolidate into fewer, larger properties.</span></span></span></li>
</ul>
</li>
</ul>

<p><span><span><span>For more information, <a href="https://www.accruit.com/contact-us">contact Accruit</a> and subscribe to our <a href="https://www.accruit.com/blog/">blog</a&gt; to learn more about 1031!</span></span></span></p>

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<p><a href="https://cta-redirect.hubspot.com/cta/redirect/6205670/07878ab4-b454-43a…; target="_blank"><img alt="Start Your 1031 Exchange with Accruit today" class="hs-cta-img" height="295" id="hs-cta-img-07878ab4-b454-43ab-90e0-95efb684dc56" src="https://no-cache.hubspot.com/cta/default/6205670/07878ab4-b454-43ab-90e…; width="800" /></a></p>

<p>Having been in the tax code for over 100 years, real estate investors have come to appreciate the value of a 1031 exchange to defer taxes on gains and depreciation recapture.<span>&nbsp; </span>Savvy investors have come to imbed this tax strategy into their process to <u>lower the cost of capital</u> and reliance on bank lending. Thus, increasing their returns.<span>&nbsp; </span>The benefits also creep through to the overall economy through the multiplier effect on other industries involved in real estate transactions and subsequent property improvements.<span>&nbsp;&nbsp;&nbsp; </span><o p=""></o></p>

<p class="MsoNormal"><a href="https://www.accruit.com/blog/costs-and-considerations-when-performing-1…; title="The benefits of 1031 exchanges">The benefits of 1031 exchanges</a> (and drawbacks) are well-known throughout the real estate investor community, but managing depreciation through the exchange is not as well understood and can be complicated.<span>&nbsp; </span>However, in working through the administrative headaches, individuals can maximize their depreciation and increase their free cash flow.</p>

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<h3>Understanding Real Estate Cost Basis Through a 1031 Exchange</h3>

<p>When transacting real estate through a 1031 exchange, also known as a <a href="https://www.accruit.com/property-owners/1031-exchange-explained&quot; title="like kind exchange">like kind exchange</a>, depreciation becomes a bit more complex than transacting in a taxable manner. That is because the purpose of the 1031 exchange from its inception in the tax code ensures continuity of investment. Essentially, it should feel like a transaction never took place and, the original investment, along with its adjusted cost basis and depreciation schedule, should carry through to the new asset. If the replacement property costs more than the relinquished property, that cost will need to add to the adjusted cost basis for depreciation. An investor cannot restart a new 27.5-year depreciation schedule on the cost basis of the replacement asset after a <a href="https://www.accruit.com/blog/primer-1031-exchanges-and-related-types-ex… exchange</a>.</p>

<p>For example, an investor purchases a single-family residential property for $200,000, and 3-years later decides to sell the property for $250,000. In those three years, the investor took $22,000 in depreciation (this figure is rounded up slightly from actual deprecation for simplicity) for an adjusted cost basis of $178,000. The investor then must add the total depreciation ($22,000) to the gain ($50,000) to come up with their funds exposed to taxation through a taxable sale ($72,000). Since the investor intends to reposition their real estate holdings, they can defer taxation on the $72,000 through a 1031 exchange. The investor decides to purchase a new residential rental property in a rapidly changing neighborhood for $300,000. The new cost basis of investment must carry over from the original property. The increased value must be added and&nbsp;the cost basis of the new property is the non-depreciated amount from the original investment ($178,000) plus the price increase over the relinquished property ($50,000) for a total cost basis for the new property of $228,000.</p>

<h3>There are two ways to depreciate real estate post 1031 Exchange</h3>

<p>Post-1031 exchanges the tax code states that you must split depreciation into two separate schedules as the preferred method. However, investors can opt-out of two schedule depreciation and depreciate the calculated cost basis on a single schedule. The latter method is typically what real estate investors pursue due to its simplicity, but&nbsp;they are leaving significant cash flow benefits on the table over time and at scale.</p>

<h3>Single Schedule Depreciation</h3>

<p>In choosing to pursue single schedule depreciation, the investor is opting out of the preferred tax code method and added benefits of two schedule depreciation in the interest of simplicity. Depreciating through this method is simple as you take the new adjusted cost basis of the asset, $228,000 in the example, and divide by 27.5 years (39 years if it’s a commercial property) to come up with the annual depreciation going forward.</p>

<h3>Two Schedule Depreciation (also referred to as Step-in-the-Shoes Depreciation)</h3>

<p>Two schedule or Step-in-the-Shoes depreciation is the tax code preferred method and has significant benefits to the investor if they can overcome the complexity. Any remaining depreciation from the relinquished property needs to continue on the original schedule through this method,</p>

<ul>
<li>In the example provided, the investor held the property for 3-years before the exchange and had an adjusted cost basis of $178,000. This remaining $178,000 would then continue to depreciate for the remaining 24.5 years on the original schedule of $7,273 annually.</li>
<li>The cost basis of the replacement property remaining, will depreciate on a new and separate 27.5-year schedule. In the example provided, the added cost basis of the replacement property is $50,000.
<ul>
<li>The annual depreciation for this portion of the cost basis is $1,818 ($50,000 / 27.5).</li>
</ul>
</li>
</ul>

<h3>Benefits of Two Schedule Depreciation or Step-in-the-Shoes</h3>

<p>The benefits of the two schedules / Step-in-the-Shoes depreciation method are apparent when comparing the annual depreciation figures. Annual depreciation in this example for single schedule depreciation is $8,291. For two schedule depreciation, that figure grows to $9,091 or an $800 increase in tax shielding depreciation for the next 24.5 years. Now a cynic might state that the gain is only temporary as the higher depreciation shield disappears after 24.5 years in this example, that individual would not understand the time value of money (cash today is worth more than cash in the future), and the compounding benefits of leveraging Step-in-the-Shoes depreciation at scale.</p>

<h3>Choosing a Depreciation Schedule through 1031 Exchange</h3>

<p>The reason investors opt-out of the preferred method of two schedule depreciation through a 1031 exchange is it can get complex. The complexity only grows when you begin to add more properties to the portfolio and the number of transactions increases as years go on. With this added complexity of two schedule depreciation, there is an added benefit in a higher early tax shield on the investment. For investors who own large portfolios of assets, the cash flow benefit can be tremendous and serve as a finance source to continue to grow their investment portfolio. Balancing complexity with the higher return will be unique to each investor and they should consult their tax advisors before moving forward with either schedule.</p>

<p>Accruit is a <a href="https://www.accruit.com/property-owners/work-with-us&quot; title="1031 Exchange Qualified Intermediary">1031 Exchange Qualified Intermediary</a> and facilitates 1031 exchanges. Always consult your CPA or tax advisor for advice pertaining to your specific tax situation. For more information, visit <a href="https://www.accruit.com/&quot; title="www.accruit.com">www.accruit.com</a&gt; or call (800) 237-1031.</p>
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<p>Special Member&nbsp;or Independent Manager services provide bankruptcy remoteness to lenders, isolating them from any potential insolvency or bankruptcy risks in commercial real estate financing transactions. &nbsp;When making real estate loans, lenders have a first mortgage on the property so that, in the event of a borrower default, the lender does not risk losing its security interest or position. However, just being subject to the bankruptcy proceedings can impede the lender’s efforts to take the property back. For this reason, the lender’s loan commitment letter typically will require the use of a new special purpose entity (SPE) LLC created by the borrower to hold title to the property. In order to prevent this type of SPE LLC from bankruptcy, a separate party, a “Special Member,” is inserted into the LLC’s operating agreement, whose accordance is required in filing bankruptcy. The operating agreement further stipulates that the special member agrees in advance not to allow the property to go bankrupt. This practice first appeared in the commercial mortgage-backed securities (CMBS) market about twenty years ago, and it was found that the loans that had adopted this bankruptcy remote feature were rated more favorably by ratings agencies like Standard &amp; Poor’s (S&amp;P). Conventional institutional lenders, such as large insurance companies and pension funds, quickly determined that their loans would also be best served if they also had a bankruptcy remote nature.</p>

<p>&nbsp;<br />
At times, the lender will require a Springing Member. &nbsp;Unlike the Special Member or Independent Manager, the role of the Springing Member only arises when there is only a single member remaining in the LLC and that member ceases to remain a member for reasons such as that person’s death. &nbsp;The Springing member “springs into action” and becomes a Special Member to avoid the LLC’s dissolution otherwise due to the fact that the last member ceased to be a member.</p>

<p><br />
Although these entities receive compensation on an annual basis for acting or remaining ready to act in their particular capacity, they have no interest in the profits or losses of the LLC and are not otherwise treated as a regular member.</p>

<p>To learn more about special member, independent manager, and springing member services, contact Accruit by emailing <a href="mailto: info@accruit.com" title="info@accruit.com">info@accruit.com</a> or calling&nbsp;<a href="tel:8002371031" tabindex="-1">(800) 237-1031</a>&nbsp;today!</p>

<hr /><!--HubSpot Call-to-Action Code -->
<p style="text-align:center"><a href="https://cta-redirect.hubspot.com/cta/redirect/6205670/24278de3-2da6-451…; target="_blank"><img alt="Special Member Services for 1031 Exchanges from Accruit" class="hs-cta-img" height="240" id="hs-cta-img-24278de3-2da6-451b-b1a6-82a687c7f6b7" src="https://no-cache.hubspot.com/cta/default/6205670/24278de3-2da6-451b-b1a…; style="border-width:0px;" width="651" /></a></p>

<p>As is widely known, many economic benefits may be obtained by taxpayers who perform 1031 exchanges.</p>

<p>Owners of real estate that is held for trade, investment purposes or use in a business are generally able to defer capital gains tax, depreciation recapture, and <a href="https://www.accruit.com/blog/1031-exchanges-state-tax-law-consideration… tax (if applicable)</a> on the sale if they perform an exchange to acquire the new property as opposed to a conventional purchase and sale transaction that does not take advantage of Section 1031.</p>

<p>By utilizing a 1031 exchange, taxpayers use that portion of the sales proceeds that they would otherwise pay to the government to potentially acquire more valuable property. &nbsp;Taxpayers may consolidate or diversify their real estate holdings through an exchange by going from one property to many or many to one. &nbsp;<a href="https://www.accruit.com/blog/1031-tax-deferred-exchanges-important-esta… planning advantages</a> are also available in an exchange because a property owner’s heirs receive a stepped-up basis in the real estate upon death with the way the law is currently drafted.&nbsp; Taxpayers may use exchange funds <a href="https://www.accruit.com/blog/can-property-improvement-costs-be-part-103… construction of&nbsp;improvements</a> that are incorporated and made a part of the real estate during the 180-day exchange period window in an improvement/build-to-suit exchange as set forth in Rev. Proc. 2000-37.&nbsp; There are even <a href="https://www.accruit.com/blog/delaware-statutory-trusts-1031-exchange-in… investments in real estate</a> that generate a rate of return without the management obligations associated with owning investment property. (https://www.accruit.com/blog/delaware-statutory-trusts-1031-exchange-in…). &nbsp; &nbsp;</p>

<p>The advantages of 1031 exchanges generally outweigh the disadvantages; however, certain costs and considerations are present that taxpayers should consider when contemplating whether to perform an exchange.</p>

<p>First, taxpayers receive a carryover basis in the replacement (new) property when exchanging real estate under Section 1031. &nbsp;The basis in the replacement property is equal to its cost reduced by the amount of gain which is not realized in the exchange transaction. &nbsp;When the real estate with the carryover basis is eventually sold, the deferred tax becomes due and payable. &nbsp;The deferred tax is just that. &nbsp;It is not a tax-free transaction.</p>

<p>Next, a 1031 exchange will result in an increase in transactional costs to taxpayers. &nbsp;These costs are oftentimes small, such as the exchange fee paid to the Qualified Intermediary for providing exchange services, title company or settlement agent charges. &nbsp;Taxpayers could also incur higher costs by way of attorneys’ or accountants’ fees related to consultation, preparation and execution of documentation associated with the deal. &nbsp;The increase in transactional costs may be greater than the tax benefit if there is little gain to be deferred (such as when the taxpayer has not owned the real estate for a significant length of time) or the taxpayer may be able to offset the gain from the sale with other losses. &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p>

<p>Moreover, the taxpayer’s net equity in the relinquished property must be used to acquire other like-kind real estate (except for any portion that the taxpayer takes as “boot” at the relinquished property closing which would not be sheltered from tax). &nbsp;While the definition of “like-kind” real estate is rather broad for 1031 purposes, the money is still tied up in the real estate and the taxpayers exchange funds held by the Qualified Intermediary are illiquid during the exchange period. &nbsp;Plus, the taxpayer will need to hold the replacement property for an obligatory period of time and use it for the qualified purpose in order to suffice the statutory requirements of Section 1031.&nbsp;</p>

<p>If the taxpayer does not perform a 1031 exchange, no constraints would exist on the use of the real estate or amount of time required to hold the property. &nbsp;The taxpayer would be free to use the property as vacation home, second home or primary residence, or perhaps sell, gift or develop it as quickly as possible.</p>

<p>Taxpayers should always consult with their independent tax and legal professionals when contemplating whether to perform a Section 1031 exchange. &nbsp;Accruit is available to help answer questions, work through the issues, and facilitate exchanges in cases where it is advantageous to do so.<br />
&nbsp;</p>

<p>IRC Section 1031, allowing for tax deferral for properties that are the subject of an exchange rather than a sale, or even a sale followed by a purchase, has been around for a very long time. In fact, 2021 marks 100 years since the Code Section became law. It has not always been a simple process for a taxpayer to meet the Code requirements but as a result of the Treasury Regulations enacted in 1991 much certainty was put in place and issues that hovered prior to the Regulations were addressed.</p>

<p>The 1991 Regulations set forth four “safe harbors” that addressed many of the problems in doing a 1031 exchange prior to that time. The fours safe harbors are:</p>

<ul>
<li>Security or Guarantees</li>
<li>Qualified Escrow or Trusts</li>
<li>Qualified Intermediary</li>
<li>Interest or Growth Factors</li>
</ul>

<h2>Security or Guarantees</h2>

<p>Prior to 1984 it was thought that exchanges for disposition of the relinquished property and the acquisition of the replacement property had to take place simultaneously. However, as a result of the legal decision in the Starker case, followed up shortly thereafter with new provisions in the Tax Reform Act of 1984, a taxpayer was able do a delayed exchange by selling the relinquished property so long as a replacement property was acquired within 180 days of the sale. However, then, and now, during that exchange period, the taxpayer’s actual or constructive receipt of the sale proceeds is taboo. Actual receipt would mean the proceeds of the sale were received by the taxpayer. Constructive receipt takes place when the taxpayer can control when he wants to receive the proceeds. An example of this is when the taxpayer’s attorney or taxpayer’s agent holds the proceeds. The fiction that existed is that the buyer of the relinquished property was to withhold payment until the taxpayer was ready to acquire the replacement property and the proceeds would be sent to the closing agent to be used for the acquisition. The seller would transfer the replacement property through the buyer to the taxpayer. So, the taxpayer was considered to have exchanged with the buyer.</p>

<p>The necessity of keeping the sale proceeds out of the control of the taxpayer was a big issue in the era after 1984. If the buyer suffered from buyer’s remorse after taking possession of the property, she might want to hold back some of the proceeds. Perhaps even worse, what if the buyer went bankrupt or had judgements against her causing the funds to be unavailable to conclude the exchange. The first safe harbor provided some certainty that if followed, the taxpayer would not be in receipt or control of the funds.</p>

<p>This safe harbor allowed the taxpayer to put a lien in the form of a mortgage or deed of trust on the relinquished property of other property of the buyer’s to secure the buyer’s payment of the funds when required by the taxpayer. Alternatively, this safe harbor also allows the buyer’s obligation to be secured with a letter of credit or by the guaranty by a third party.</p>

<p>As a practical matter in the current era this safe harbor is seldom used. Other options are more practical and still keep the taxpayer out of actual or constructive receipt.</p>

<h2>Qualified Escrows or Trusts</h2>

<p>This safe harbor involved the buyer placing the sale proceeds into an escrow or trust account. The thought being that the use of an escrow or trust could essentially take the buyer out from further involvement in the taxpayer’s exchange while not putting those funds under the taxpayer’s control. To some extent this safe harbor is the codification of the use of a “Starker Trust” which came into vogue after the Starker case and the 1984 Tax Act. This safe harbor is still in use. Another benefit to this safe harbor is that it effectively keeps the exchange proceeds segregated from any proceeds that are otherwise comingled in the account of the company facilitating the exchange. This has been a problem for taxpayers at times in the past where the facilitator declared bankruptcy. Further the terms of the escrow or trust generally require the joint direction of the taxpayer and facilitator to the third-party escrow agent or trustee which limits an unscrupulous facilitator’s ability to unilaterally move the money.</p>

<h2>Qualified Intermediary</h2>

<p>This safe harbor is the most important of them. It is not enough for a taxpayer to sell and buy a property within the applicable time frame. Rather the taxpayer needs to exchange one property for another. Prior the issuance of the Regulations, for all practical purposes the party with whom the taxpayer did an exchange was the relinquished property buyer. Rather than pay the taxpayer the purchase price, the buyer used those proceeds to acquire the taxpayer’s target replacement property and then transferred that property to the taxpayer. For a variety of good reasons buyers did not want to take on this role, they simply wanted to pay the negotiated purchase price and move on.</p>

<p>So, in dealing with this conundrum, the drafters of the Regulations decided to introduce a new player into the exchange to act as an intermediary between the taxpayer and his buyer and seller. Any person or company that was not disqualified under the Regulations was therefore a “Qualified” Intermediary (“QI”). For tax purposes, using this safe harbor entails the taxpayer transferring the relinquished property to the QI who transfers it to the buyer and for the seller to transfer the replacement property to the QI who transfers it to the taxpayer. Hence the taxpayer transferred the old property to the QI and received the new property from the QI. The buyer and seller are effectively removed from the exchange process and the taxpayer is deemed to have done an exchange with the QI.</p>

<p>The QI also typically provides a secondary function. That is to hold the funds for the benefit of the taxpayer. So in lieu of using a third party to hold the funds under an escrow or trust, the QI places the funds in separately identifiable accounts with a bank and holds the funds FBO taxpayer.</p>

<h2>Interest or Growth Factor</h2>

<p>Again, harkening back to the time prior to the 1991 regulations, it was difficult to deal with the interest that accrued on exchange funds during the period up to 180 days to wrap up the exchange. If the taxpayer received the interest, then she might be deemed to have owned the deposited funds. That would put her in constructive receipt and taint the exchange. One alternative was to allow the interest to get paid to the buyer, but that was an unintended windfall for the buyer. At times, the taxpayer and buyer would try and estimate the anticipated interest and add that to the purchase price of the property. That way the seller actually received the value of the interest, but the actual interest was paid to the buyer. The fourth safe harbor dealt with this problem and simply provided that the taxpayer would not be deemed in constructive receipt of the exchange funds on account of the interest accruing for her benefit.</p>

<p>As can be seen, the 1991 Exchange Regulations cleared up a lot of uncertainty that existed prior. In particular the safe harbors set forth made delayed exchanges much simpler and provided comfort to taxpayers and their advisors alike in structuring a delayed exchange.</p>

<h2>THE SITUATION</h2>

<p>Greg and Peter are brothers who have each inherited some money. After the relevant estate and/or inheritance taxes, they each received $160,000. They each want to invest in real estate, but they disagree on the strategy. They both have full-time careers, so their strategies need to account for those obligations as well. Greg plans to buy something to fix and then flip, hopefully for a profit. Peter would like to buy something to rehab and then rent. Working together, they find two homes in the same neighborhood, and complete their acquisitions approximately 3 months after receiving their inherited funds, each spending $160,000. They immediately commence making repairs and upgrades in the spare time. After about 10 weeks, they have both completed their rehab work, and have each spent $45,000 in the process. Both Greg and Peter now have $205,000 invested into their respective properties. This number constitutes their basis in the property for determining taxation at a time of future sale of the property.</p>

<p>Greg believes that he can sell his property for $225,000, earning him a $20,000 profit ($12,150 after brokerage commissions and transfer taxes). To compound his tax burdens, because Greg has owned the property for less than one year, he will be subject to short-term capital gains taxes, which are equal to his highest marginal income tax rate. Peter plans to hold his property and is confident that he can rent his property for $1,600 per month, or $19,200 for the first year.</p>

<h2>THE PROBLEM</h2>

<p>From the date Greg purchased his property until the date he sold it was a grand total of six months. When Greg sold his fix-and-flip property, he was introduced to the buyer by the buyer’s real estate agent. Thus, he will be paying a 3% fee to the broker, as well as state and federal taxes on his profits:</p>

<table align="center" border="0" cellpadding="5" cellspacing="1" style="width:750px;">
<tbody>
<tr>
<td>Brokerage Commission</td>
<td>($225,000 x 3%)</td>
<td>$6,750</td>
</tr>
<tr>
<td>State R/E Transfer Taxes</td>
<td>(estimated)</td>
<td>$1,000</td>
</tr>
<tr>
<td>Federal Short-term Capital Gain Tax</td>
<td>($12,150 x 35%)</td>
<td>$4,252</td>
</tr>
<tr>
<td>State Short-term Capital Gains Tax</td>
<td>(estimated 6%)</td>
<td>$729</td>
</tr>
<tr>
<td>&nbsp;</td>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td><strong>Net cash after taxes and expenses</strong></td>
<td>&nbsp;</td>
<td><strong>$212,168</strong></td>
</tr>
<tr>
<td>&nbsp;</td>
<td>(Total Tax &amp; Expense Loss 5.7%)</td>
<td>&nbsp;</td>
</tr>
<tr>
<td>Net profit after taxes and expenses</td>
<td>($212,168 - $205,000)</td>
<td>$7,168</td>
</tr>
<tr>
<td><strong>Return on Investment</strong></td>
<td><strong>($7,168/$205,000)</strong></td>
<td><strong>3.5%</strong></td>
</tr>
</tbody>
</table>

<h2>THE SOLUTION</h2>

<p>Peter listed his property for rent, and the new tenant moved in on the same day that Greg sold his property. Peter’s tenant will be paying $1,900 month, or $22,800 for the year. Peter’s tax situation at the end of the year is a little different:</p>

<table align="center" border="0" cellpadding="5" cellspacing="1" style="width:750px;">
<tbody>
<tr>
<td>Federal Income Tax</td>
<td>($19,200 x 35%)</td>
<td>$6,720</td>
</tr>
<tr>
<td>State Income Tax</td>
<td>(estimated 6%)</td>
<td>$1,152</td>
</tr>
<tr>
<td>Total Taxes</td>
<td>&nbsp;</td>
<td>$7,872</td>
</tr>
<tr>
<td>Total estimated tax owed</td>
<td>($19,200 - $7,872)</td>
<td>$11,238</td>
</tr>
<tr>
<td><strong>Return on Investment</strong></td>
<td><strong>($11,328/$205,000)</strong></td>
<td><strong>5.5%</strong></td>
</tr>
</tbody>
</table>

<p>In our current example, it took Greg three months to find and buy the first property. It then took him six months to make the repairs and sell it, for a total investment cycle of 9 months. If Greg is aggressive, he can accomplish four of these fix-and-and flip transactions in three years:</p>

<table align="center" border="0" cellpadding="5" cellspacing="1" style="width:750px;">
<tbody>
<tr>
<td><em>Transaction 1:</em></td>
<td>&nbsp;</td>
</tr>
<tr>
<td>Invested</td>
<td>$205,000</td>
</tr>
<tr>
<td>Sold</td>
<td>$225,000</td>
</tr>
<tr>
<td>Net after commission/taxes</td>
<td>$212,168</td>
</tr>
<tr>
<td>Cash profit</td>
<td>$7,168</td>
</tr>
<tr>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td><em>Transaction 2:</em></td>
<td>&nbsp;</td>
</tr>
<tr>
<td>Invested</td>
<td>$212,168</td>
</tr>
<tr>
<td>Sold</td>
<td>$233,000</td>
</tr>
<tr>
<td>Net after commission/taxes</td>
<td>$219,719</td>
</tr>
<tr>
<td>Cash profit</td>
<td>$7,551</td>
</tr>
<tr>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td><em>Transaction 3:</em></td>
<td>&nbsp;</td>
</tr>
<tr>
<td>Invested</td>
<td>$219,719</td>
</tr>
<tr>
<td>Sold</td>
<td>$241,000</td>
</tr>
<tr>
<td>Net after commission/taxes</td>
<td>$227,263</td>
</tr>
<tr>
<td>Cash profit</td>
<td>$7,544</td>
</tr>
<tr>
<td>&nbsp;</td>
<td>&nbsp;</td>
</tr>
<tr>
<td><em>Transaction 4:</em></td>
<td>&nbsp;</td>
</tr>
<tr>
<td>Invested</td>
<td>$227,263</td>
</tr>
<tr>
<td>Sold</td>
<td>$249,000</td>
</tr>
<tr>
<td>Net after commission/taxes</td>
<td>$234,807</td>
</tr>
<tr>
<td>Cash profit</td>
<td>$7,544</td>
</tr>
<tr>
<td><strong>3-year total profits</strong></td>
<td><strong>$29,807</strong></td>
</tr>
</tbody>
</table>

<p>In three years of fixing and flipping houses, Greg has netted a total of $29,807 in income. In this same time period, Peter has rented his property for $19,200 per year for the three years, netting $11,328 per year or $33,984, about 14% more than Greg netted.</p>

<p><br />
Peter is now considering selling his property as part of a Section 1031 Exchange. Historically, the national average for real estate appreciation is about 3.8% per year. Thus, Peter expects to sell his original investment property for about $250,000 (which is comparable to the value of Greg’s last sale at $249,000). If Peter sells his property outright, he can expect to pay taxes as follows:</p>

<table align="center" border="0" cellpadding="5" cellspacing="1" style="width:750px;">
<tbody>
<tr>
<td>Federal Capital Gain Tax</td>
<td>($45,000 x 20%)</td>
<td>$9,000</td>
</tr>
<tr>
<td>Affordable Care Act Surcharge</td>
<td>($45,000 x 3.8%)</td>
<td>$1,710</td>
</tr>
<tr>
<td>State Capital Gains Tax</td>
<td>($45,000x6%)</td>
<td>$2,700</td>
</tr>
<tr>
<td><strong>Total Taxes</strong></td>
<td>&nbsp;</td>
<td><strong>$13,410</strong></td>
</tr>
</tbody>
</table>

<p style="margin-bottom:11px">&nbsp;</p>

<p>Peter’s tax advisor has explained the value of an IRC Section 1031 tax-deferred exchange. Peter now knows that he can effectively defer recognition of $13,410 in state and federal taxes by structuring his transaction as part of a 1031 exchange. Accordingly, upon the sale of the property, the exchange proceeds will be sent directly to Peter’s qualified intermediary (“QI”) to be held until the purchase of his replacement property.</p>

<p><br />
Within 45 days after the closing on the sale, Peter properly identified his replacement property. (More information about identification and receipt of replacement properties can be found at <a href="https://www.accruit.com/blog/what-are-rules-identification-and-receipt-…; style="color:#0563c1; text-decoration:underline">Rules for Identification and Receipt of Replacement Property</a>.) Closing on his replacement property acquisition occurred well within the 180-day exchange period, utilizing the exchange proceeds held by the QI.</p>

<p>&nbsp;</p>

<h2>THE RESULT</h2>

<p>Greg spent much of his free time over the past three years managing the upgrades and renovations at four fix-and-flip properties. Three years on, Greg has limited options with his property. He cannot currently participate in a 1031 exchange like Peter. He could continue his path of fix-and-flip, spending much of his free time managing the improvements on each new property. He could also consider changing to Peter’s strategy and renting his current property.</p>

<p>During the same three years, Peter enjoyed the relatively passive income afforded by his rental property, earning about 14% more income in the process. At the same time, the net value of the real estate that the two brothers held at the end of the four years was virtually identical.</p>

<p><a href="https://www.accruit.com/property-owners/1031-exchange-explained#simple-… the step-by-step processes</a> involved in completing a tax-deferred exchange, which you may review with your tax and legal advisors.</p>