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1031 ADVISOR December 2009 |
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Harry Potter, Illusions and Section 1031 Exchanges Harry Potter learned to use the disillusionment charm to reveal and uncover hidden items and secrets. We will uncover a few financial secrets today using a Section 1031 disillusion charm of our own. We will reveal that Section 1031 exchanges can:
Charming indeed! Normally when an investment or business asset is bought, a rate of return is computed using the expected revenue earned over the life expectancy of the investment. This includes every type of business or investment asset. However, for today, we will use the purchase of truck used to haul business assets over long distance a.k.a. tractor trailer. The timing of other factors, such as the payment of taxes, depreciation, interest and principal repayments, are infrequently or superficially analyzed. While it is widely accepted that gain on the sale of a used tractor trailer may be offset by depreciation deductions on the acquisition of a new truck, most companies fail to take into account the impact on cash flow, debt expenses and profitability when income taxes are paid in the year of sale. Take two Companies, A Inc. and B, Inc. Each company sells used trucks worth $100,000 and purchases new trucks worth $100,000. Each Company earns $1500 per week in gross freight revenue for a total revenue of $75,000 per year. A, Inc. is taxed on the sale at 40% and pays $40,000 in taxes. A, Inc. must borrow $40,000.00 or use cash on hand to purchase it’s new truck. If A, Inc. uses cash on hand, it loses the opportunity to make revenue with that cash, known as opportunity cost. This is typically much higher than the cost of a loan, if the Company can obtain a loan. At the end of 5 years, after income taxes, interest expense, loan repayments depreciation deductions, A, Inc. has $164,000 in cash, representing an annual return on investment of 32.8%. B, Inc. treated the sale as a Section 1031 exchange and paid no taxes. At the end of 5 years, after income taxes, B, Inc. has $225,000 in cash. B, Inc. has $61,000 more cash to invest in its business, lower debts, lower interest expense, lower income taxes and higher profits. B, Inc’s annual return on investment is 45% or 137% higher than A, Inc. This analysis is valid for Companies, big and small, in industries as varied as manufacturing, transportation, utilities and real estate. Let Strategic Property Exchanges, LLC lead you to financial prosperity with 1031 Asset Manager®.
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