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December 28, 2015

Saving Taxes, Building Wealth and Improving Cash Flow


The old adage “buy low and sell high” describes the goal of many investors in real estate ventures. Other than travelling back in time, how can today's investors achieve this goal in real estate ventures?

Let's say that I am offered an opportunity to purchase a set of eight apartment buildings for $2,000,000. I know that they are in great locations but they need to be updated to increase rents. The bank will provide $1,500,000 on the purchase based on current rental rates or $2,000,000 if fully updated with higher rental rates. How can I purchase the buildings and reduce my out of pocket investment in the buildings?

Section 1031 Exchanges allow investors to minimize their out of pocket investment in investment property by allowing the tax free transfer of equity from one property to another property. I can sell another property with $500,000 of gains and roll those gains into the new buildings and either use the money as a
down payment today or use the funds to improve the property during the six-month exchange
period. Either way, I do not need to withdraw additional funds from my savings account. I will be able to move my untaxed gains from one property to another, based on my assessment that the potential future income and future value in the new project is better than the property to be sold. So, at the end of the day, my out of pocket cost will just the amount of the loan.

This is true whether I am buying existing property or building or developing property. I can build a new project for $2,000,000 with a loan from the bank and then sell a property and pay down my bank loan by the amount of my equity thus increasing my future cash flow and reducing my liabilities, all without paying taxes. Recent changes in tax law now allow me to build improvements on land I already own as a Section 1031 exchange.

Section 1031 has been the primary driver of real estate development for commercial as well as residential
properties since 1921. The vast majority of investment and commercial property is acquired through Section 1031 exchanges. Furthermore, the Internal Revenue Service has significantly loosened their rules permitting different ways to reinvest with Section 1031 Exchanges.

Finally, the changes in federal and state estate taxes now permit the forgiveness of Section 1031 gains that have accrued over the lifetime of owners once the property passes to their heirs, up to $10,900,000
worth of property, net of liabilities.

This blog does not offer legal advice, but it can provide some benchmarks that readers can use to see if they, in the course of replacing business or investment assets, can potentially defer or eliminate taxes on
those transactions.

The Fitzpatrick Team works with Strategic Property Exchanges, LLC (SPE) to accomplish all of your exchange needs. With over 25 years of experience, the experts at SPE take full responsibility coordinating for details and tax impact of each and every exchange. Click here to contact SPE.

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