Spring Season Brings Tighter Seller's Market

After an unusually cold winter, which inevitably slows the real estate market down, the beginning of the Spring season is now here, with warmer weather, and a huge increase in activity.  Judging from the decreasing number of days on market for new listings, and the huge buyer demand, it will once again be an active seller's market, with prices likely to rise by summer's end.

How does this affect 1031 exchanges?  A seller's market poses some definite challenges, especially when it comes to acquiring a replacement property.  First, since there is no guarantee that a property identified will actually go under contract, we advise buyers to begin their search for the replacement property immediately after closing on the sale of the old property.  This way, if the 3 properties that were identified all go under contract with someone else (a common occurrence), the buyer still has some window of time to identify 3 others, up to the 45 day limit.  Next, we suggest doing what it takes to actually close.  If the deal falls apart for some reason, again, you are under a time constraint to identify something else.  This means get your inspection, and any other due diligence, as well as contract negotiations, asap.  Make sure your financing is solid as well, and work with a reputable lender on this.

A 1031 exchange is easier in a buyer's market, because, it is not the sale of the old property that needs to be done in a given time frame, it is the purchase of the new one.  In a buyer's market, there is so much choice, and, even with the time factor, things can be a little more relaxed.  But in this market, time is even more of the essence than usual, and it is imperative to understand the limited wiggle room a buyer has, especially one performing a 1031 exchange.

Retiring to Austin and Want Investment Property Closer to Home

I have had a couple of clients over the last few months move to the Austin area from out of state, and I continually work with people looking to retire to the Central Texas area, due to its affordability and quality of life.  Some of these clients have indicated to me that they own rental property near where they were living, and, as we talk, also indicate that it would be nice to have their rental property closer to home, where they now live.

It is surprising to me that most have no idea about 1031 exchanges.  Many have tax advisors and some have financial planners, however, this topic does not seem to come up.  I always try to educate them, usually on the fly, and as we are property hunting, and thereafter.  This is something so easy to do, without having to lose money on capital gains when you sell the rentals elsewhere.  It can also be done piecemeal, to get a feel for the process, and become comfortable with it.

For all intents and purposes, you are just re-titling a property you previously owned into a new one.  And, now, your rentals can be nearby once again, even though you might have shifted your personal residence to another state.  Ask me for details, or visit www.1031exchange.co for more details!

As the Real Estate Market Heats Up, More People Do 1031 Exchanges

Since the real estate market peaked back in 2006, then headed downward or remained stagmant over the next five years, 1031 exchanges became much less common.  As they say, you've got to have a capital gain in order to worry about paying tax on it.  The few exchanges that were done over the preceeding 5-6 years were usually from investors who had held on to their property for a very long time, decades, and were now looking to sell, defer the capital gain, and buy a new property.

Now, however, with inventory being so low, and prices rising dramatically here, and all across the nation this past year, 1031 exchanges are once again proving their value to wise investors.  And, wrapping up the busy summer season here, it has certainly been a seller's market!  And, if the demand continues, interest rates stay near historical lows, and the US economy continues to recover, you can bet that real estate will remain a profitable investment.  Even with a slow recovery, real estate has always proven to be a good hedge against inflation, and with the continued pumping up of the economy by the Federal Reserve, we are sure to see inflation's effects in the coming years.

There is no need to pay the hefty capital gains and depreciation recapture taxes for someone looking to sell investment property.  A 1031 exchange is a time-tested method of keeping your capital, and allowing it to continue to compound, and work for you.  Talk to our exchange specialists at www.1031exchange.co and learn how to protect your real estate investment portfolio.

Presenting Offers with 1031 Exchange Language

Both when buying or selling a property, the counter-party must be informed of the intention of your client to perform a 1031 exchange.  The wording in the contract is usually placed in the Special Provisions section of the contract, with the following wording, or very similar to it:  Seller is aware that Buyer intends to perform a 1031 Tax Deferred Exchange pursuant to Section 1031 of the Internal Revenue Code.  Seller accordingly agrees to an assignment of the rights under this contract by the Buyer to (Name of Qualified Intermediary), a Qualified Intermediary.  Seller agrees to cooperate in such exchange at no cost or liability to Seller.

Sometimes the other party, or their agent, is completely unfamiliar with what a 1031 exchange is.  Here, it is important for your Realtor working on your behalf to be able to explain what it is in easy to understand terms, rather than relying on them to google it, and get lost in something that seems complicated, and subsequently shy away from your offer, assuming you are the Buyer in this case.

I usually explain it by stating that the transaction will operate in exactly the same way as an ordinary transaction would, and will not affect the counter party in any substantial way.  The only difference that they will see is where the money comes from - the QI instead of the buyer themselves.  I simply explain that this QI is acting on behalf of the buyer, and must follow the buyer's instructions in dispersing the funds, which belong completely to the buyer.  All other facts of the contract remain the same.

For a seller doing a 1031, it is just a matter of putting the wording in the contract.  Nothing is really seen differently from a buyer's side in that case, except for some wording on the HUD-1 settlement statement.  I usually just explain that this wording must be put into the contract to show legal intent of the seller to do an exchange, and nothing more than that.  It will not affect the transaction.

What "Like Kind" Really Means and Why You Don't Have to Find Someone to Swap Properties With

Ok, these two topics come up frequently enough with people unfamiliar with 1031 exchanges that I thought I should address them both.  First, let's talk about Like Kind, and what that means according to the law.  For my clients, it is as simple as "real estate" for "real estate".  This means that you can exchange an apartment building for raw land; a commercial office building for a residential rental home; a fourplex for a motel.  The only caveat is that it be used for income generating purposes or investment, NOT as a personal residence.  But that's it.

There is the misconception that this like kind provision means that it has to be the same type of real estate.  Not True!  The things that you cannot do in a valid 1031 exchange are trade say, an office building for gold, or an airplane for a rental condo.  Here, you are breaking the like-kind provision.  But as long as you stick to real estate for other real estate, you are fine.

Another common misconception I find is that you actually have to find someone that wants your property, and you want theirs, in order to do an exchange.  That would be tough!  In fact, I have yet to see it happen.  One party may want to trade with another, but to have this kind of agreement between both sides is exceptionally rare.  Even when it does happen, still, one or both parties still likes to "look around" to see what else they can get, just like any other buyer would do.  This exchange in a pure sense does not make sense for most people, since finding a counterparty that is in agreement and wanting the same thing is like finding a needle in a haystack.

The 1031 exchange provisions allow a seller to liquidate their real estate asset, have the money held by an intermediary, and then be able to purchase ANY property that they choose.  No need for the counter-party to even be involved in swapping or trading, other than notifying them that you are doing an exchange.  For the counter party, it is a transaction just like any other, from both the buy and sell side.  Call me for more details, or visit my site, www.1031exchange.co

Money Placed with a Qualified Intermediary Cannot Be Touched

In doing a 1031 exchange, it is vital that a client never touch any of the proceeds from the sale of the relinquished property.  These funds must be placed with an intermediary at the closing of the sale, if being used to purchase the replacement property.  Sometimes people like to keep some of the cash proceeds from the sale, and this is permissible, so long as instructions are given to the QI beforehand.  Documents can then be prepared showing that the amount of cash that is kept is outside of the exchange.  Keep in mind, however, that this cash will be taxed.  If there is any money left over with the QI after the exchange has taken place, an investor must still wait for the 180 days to be over before getting the remainder of the cash back.

Another thing to remember is that when you are purchasing your new property, only the earnest money can come from the funds held by the intermediary.  I suggest to clients that the option money (in Texas contracts), as well as the cost of an inspection, and loan fees payable up front be paid directly by the buyer.  This is because, if you, as the purchaser, do not close on the property, there is a chance that you will be deemed to have "touched the funds", thereby invalidating the whole exchange.

These rules may seem strict, but need to be followed closely so that your 1031 exchange is airtight against the taxing authorities if they ever argue the case.  For more information, check out our site at www.1031exchange.co

Doing a 1031 Exchange in a Seller's Market

It's a seller's market here in Austin, and in much of the country.  There is very little inventory, and some properties are getting multiple offers the minute they hit the market.  How does this impact a 1031 exchange?  Since sticking to the timeframe laid out in the 45 day and 180 day rules is a must, planning the execution of the exchange becomes key.

First, DO NOT wait until the last minute, (i.e. the 45th day) to identify your 3 properties, without ever really looking at or considering them in detail.  You'd be surprised how often people wait until the last few days, then begin to look for replacement properties.  The process of looking for a replacement property should begin when you know you will close on the relinquished property, likely a few weeks or so before the actual closing.

Keep in mind that in a seller's market, some of the properties you are considering may not even be available once you are ready to make an offer.  And there's no telling if the offer you make on the first property will even be accepted and you'll go under contract.  It is wise to at least have one property that you can make an offer on in mind very soon after you close.  If it does not go through, identify some other properties that are also acceptable to you, and don't spend too much time hesitating or negotiating.  Remember, the capital gains you are saving is worth a little bit of wiggle room in negotiating, especially from the buyer side.

If you've waited until the last day to identify your three properties, then you must end up closing on one of them.  Don't wait to get one under contract, or you could come down to your last choice, and very little negotiating room, or worse, no choices at all, and a failed exchange.  Even though you have, in theory, 4 1/2 months until you have to close, this again becomes a case of "don't wait till the last minute".

Another solution to all of this is to do a Reverse Exchange, which I will cover in another post!  Visit us at 1031 Exchange Austin for more information on this and other 1031 topics.