Ken Tharp - Section 1031 Exchanges, Iowa/U.S.

In what could hardly be termed a surprise, the Des Moines Register reported on February 21, 2009 that farm land values in Iowa declined 6% during the final quarter of 2008 according to the Federal Reserve Board of Chicago. This is the first such drop in a decade. The primary contrbuting factor is the sharp decline in commodity values since the summer, in many cases as much as a 50% drop.

The 6% drop in Iowa was discovered during a survey of 209 banks in the upper Midwest, including not only Iowa, but Indiana, Illinois, Wisconsin and Michigan as well. Iowa's decline was the sharpest of the five states surveyed.

Mike Duffy, the often-quoted economist at Iowa State University, pointed out that approximately 80% of farm sales in the past year or so have been to neighboring farmers. He said "Up to now, farmers have probably kept farmland prices up simply because when a good piece of land they've had their eyes on for a long time comes up for sale, they'll bid for it even if the price is high. They may start backing off and maybe we'll see some more outside investors come in, particularly since farmland did better than just about anything else as an investment last year."

Randy Hertz of Hertz Real Estate Services, offered this on farm land values: "What has happened is that we're probably about even with a year ago in farm values," indicating that the decline comes after an increase during the previous nine months, leaving values about flat during 2008. "We had a big boost in midyear when commodity prices shot up and then we've probably seen about a 10 percent decrease since then," Hertz said.

Mr. Hertz also noted that there are still some farmland that commands high prices. Specifically, Hertz cited two parcels near Prairie City that sold in the previous week for $7,050 and $6,850 per acre for top-quality land.

Most longtime observers of Iowa agriculture doubt that what is to come will be anything like the farm crisis of the 1980s, when land prices dropped over 60% over a seven-year period. Most believe that the high leverage many farmers used back in those times was the cause of many of the problems, and for the most part that leverage does not exist today. Hertz said. "Today they're in a much better cash position compared to 25 years ago. They have more equity in the land, and their loans are less likely to go upside-down on them."

****

Please consider IOWA EQUITY EXCHANGE as your trusted source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Ken Tharp

800-805-1031 toll free

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY. PRECISION. SECURITY.

Copyright © 2009 By Ken Tharp, All Rights Reserved. * Have Iowa Farm Land Values Peaked? * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

Does it confuse you when you hear that property in an exchange must be exchanged for "like-kind" property? In the talks that I give to real estate agents, investors, attorneys and accountants, I think I've hit on an easy way to determine whether or not the property being sold is like-kind to the property being purchased.

Before getting into the details, let's first establish that virtually all real estate is like-kind to virtually all other real estate. That makes it pretty simple, doesn't it? But there is one major qualifier. Property in an exchange must have been "held as an investment or used in the pursuit of a business or trade." Those words come directly out of Section 1031 of the code.

That qualifier is the basis for my easy way to determine whether or not properties are like-kind. Here's the "secret:" Regarding the property you intend to sell, ask yourself this question:

Did I hold this property as an investment or use it in the pursuit of my business or trade?

If you can honestly answer, "Yes" to that question, then the property will qualify for the exchange. However, that is only half of the battle; the property you intend to purchase must also qualify. In order to determine whether it does, ask yourself this question:

Do I intend to hold this property as an investment or use it in the pursuit of my business or trade?

Again, if you can honestly answer that question, "Yes," then it also qualifies and you have identified like-kind property for your exchange.

EXAMPLE:

So, what kind of real estate doesn't qualify as like-kind? The easy answer is "property that hasn't been held as an investment or used in the pursuit of a business or a trade." What that means in English is that if you purchased a property without the intent to hold is as a long-term investment, it does not qualify for an exchange. Property purchased to flip would be an example. Can one's intent change? Yes, but it is up to the exchanger to establish that intent has changed through such things as holding the property out for rent, actually renting it, etc.

In conclusion, if you just remember to ask yourself (or have your client ask himself) those two questions, you will know whether or not your properties are like-kind to one another.

****

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Ken Tharp

800-805-1031 toll free

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY. PRECISION. SECURITY.

Copyright © 2009 By Ken Tharp, All Rights Reserved. * Is the Term "Like-Kind" Confusing to You? Here's a Simple Explanation * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

learly, the overriding reason is the ability to defer payment of capital gain taxes, including the recapture of depreciation. With depreciation recapture at 25% (or more, depending upon the type of depreciation taken and the period over which that depreciation was taken) and federal capital gain tax at 15%, plus state capital gain taxes (depending upon the state, of course), taxes can easily account for 30% or more of the gain recognized. But there are other reasons that taxpayers exchange. Most exchanges have secondary reasons for exchanging in addition to tax deferral. Among those reasons are:

1. Consolidation. Example - taxpayer owns several properties, perhaps in different states, and wishes to consolidate his holdings into one property.
2. Diversification. Example - taxpayer owns one large property and wishes to diversify her holdings over a wider group of properties.
3. Relocation. Example - taxpayer has moved to new location and wishes to move his investment to the same location.
4. Reduction of management headaches. Example - taxpayer has owned high-maintenance property and wishes to reduce management responsibilities by exchanging into triple-net leased property.
5. Solution to partnership problems. With proper advance planning, property owned by a partnership can be sold and the partners can go their own ways, some choosing to exchange and others cashing out.
6. Increase cash flow. Example - taxpayer owns raw land that produces little or no income and wishes to exchange into income-producing property.
7. Estate planning reasons. Example - taxpayer owns one property but has three heirs who do not agree on how to dispose of the property after the death of the taxpayer. Taxpayer can exchange out of one property into three similar properties and each heir can decide how to handle his or her own property.
8. Re-leveraging of equity. As each year of ownership passes, one's equity in a property typically increases. Generally, the return on equity that the property produces decreases annually. Exchanging allows a taxpayer to re-leverage her equity.
9. The increase of equity by buying at a discount. If you believe, as the old real estate adage goes, "You make your money when you buy," should you not buy more often? A rhetorical question, to be sure, but if you are able to buy at a discount, tax-deferred exchanges can create wealth more quickly than any other technique.
10. Debt issues. Example - taxpayer owns a fleet of vehicles for his business. His old practice was to sell 25% of them each year and replace them with new vehicles. By taking the maximum deductions, his accountant advised him that he came out ahead by borrowing the money to purchase the new vehicles. In today's world, where borrowing is more difficult, the savvy business owner recognizes that by structuring this transaction within a 1031 exchange, he can reduce or eliminate his need to borrow money and likely end up ahead in both cash flow and tax benefits.

****

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Ken Tharp

800-805-1031 toll free

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY. PRECISION. SECURITY.

Copyright © 2009 By Ken Tharp, All Rights Reserved. * The Top Ten (Actually, Eleven) Reasons People Use Section 1031 Tax-Deferred Exchanges * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

What the title of this blog refers to is whether or not it makes sense to sell or buy more than one property in a single Section 1031 tax-deferred exchange. First we must establish the fact that more than one property can be sold and/or purchased within one 1031 exchange. In other words, I can sell two or more properties and combine those sales into one exchange, out of which I can buy one replacement property. Likewise, I can sell one property and buy two or more properties as my replacement property in an exchange. Or I can sell two or more propertes and buy two or more properties as my replacement property in a single exchange.

Many times clients or potential clients contact us with questions about the benefits and the hurdles when considering whether to combine multiple properties into one 1031 exchange. Let's try to break it down. Here are some questions to consider when making such a decision:

Regarding multiple relinquished properties:

• Will my relinquished properties all close at once, or within a short period of time? (If so, it will make combining them into one exchange much easier.)
• If not, am I sure that they will all close with enough time remaining to complete the exchange within the 180 days allowed?

Regarding multiple replacement properties:

• Will I be able to complete the purchase of all replacement properties within the 180 day exchange period?

Regarding multiple relinquished properties AND multiple replacement properties:

• Will my relinquished properties close in a sequence that will allow me to close on the replacement properties in accordance with my purchase agreements and/or the sellers' requirements?

As I often say when discussing Section 1031 exchanges, sometimes an example or two is better than all of the explanation in the world.

For the first example, let's assume that I own two properties and each one is worth $150,000. I would like to sell both and purchase as my replacement property one larger property valued at $300,000. Doable, to be sure, but there are some potential pitfalls. Let's say my first sale closes on January 1. This establishes the beginning date of the exchange, which means it will end 180 days later on June 30 (assuming we're not in a leap year). The seller of the property I want to buy is willing to wait until April 1 to close. On March 15, the date the second sale was scheduled to close, the buyer of my second property runs into difficulty obtaining financing, or worse, backs out of the agreement. The seller of the property I want to buy may allow me an extension, but he may not. Even with an extension, if the second relinquished property doesn't close in time to allow me to close on the property I want to buy, my exchange is in serious jeopardy of failing.

For the second example, let's assume the reverse: I own one property that I am selling for $300,000 and I want to purchase two properties, each worth $150,000. This setup is usually less problematic than the first example, but there still can be issues. Let's again say that closing of the relinquished property occurs on January 1. My exchange account is opened with $300,000, and I identify only the two properties that I want to purchase as my potential replacement property. On March 15, I close on the first property. However, the second property has a cloud on the title, or there is an environmental issue that must be resolved. There could be any number of possible problems that could keep the second property from closing. (This is one reason to always identify a reasonable number of potential properties during the ID process, subject of course to the limitations that the rules impose, so that you have a fallback plan if something prohibits you from closing on your first choice.) If the issues preventing the purchase from being completed are not resolved prior to the end of the exchange period on June 30, my exchange will only be partially successful and I may have a sizable tax bill for the money I could not put into the second property I had planned to purchase.

The answer to the question of whether you should combine properties into one exchange or not is the favorite answer of all advisors: It depends. With proper advance planning and careful oversight, it is entirely possible to complete a successful exchange with multiple properties on either or both sides of the exchange; we do it on a regular basis for our clients. But do your homework and make sure your ducks are in a row before entering into what is typically an endeavor that carries a little more risk than a regular one-property-for-one-property Section 1031 exchange.

****

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange

Ken Tharp

800-805-1031 toll free

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY. PRECISION. SECURITY.

Copyright © 2009 By Ken Tharp, All Rights Reserved. * To Combine or Not to Combine - That is the Question * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

Here's another spreadsheet for your entertainment and enlightenment. If you've been following this blog for awhile, you may remember an earlier spreadsheet that compared buying and holding a property for ten years to buying the same property, holding it for five years, exchanging into another property, and holding the new property for another five years.

This new spreadsheet takes a little different approach. Its purpose is to compare the value of exchanging to simply selling and reinvesting without the benefit of an exchange.

Remember, there are four sources for income/profit from a real estate investment:

1. Cash flow before taxes
2. Tax benefits
3. Principal reduction
4. Appreciation

This spreadsheet ONLY addresses #4, Appreciation.

In the first section of the spreadsheet, you can enter the assumptions that you want to use. Here's a screen shot of that section, populated with some assumptions I made:

You can see that this sample investor is starting with $25,000 as a down payment. He's going to finance 90% of the purchase price of this new property.

When the property is sold, the assumption is that the sale expenses will be 7% of the total sale price, and that depreciation recapture, federal capital gain taxes and state capital gain taxes will total 30% on the gain recognized.

We go on to assume that properties will appreciate at 3% per year over the time frame of the comparison, and that each property will be held for five years.

All of these numbers are variable; you can use whatever you think is fair. The assumptions apply to each purchase and sale throughout the time frame of the comparison.

The next section of the spreadsheet calculates the net profits and available capital to move into the next property. It looks like this:

Comments: The Net Profits after the first period (which is five years, based upon the assumptions entered above) without the benefit of a 1031 exchange are $13,672. Adding the profits to the original $25,000 gives the Available Capital of $38,672 to use on the next property. In comparison, the exchanger would have $19,531 in profits and $44,531 as a down payment on the next property. Profits after the second period start to diverge between the exchanger and the non-exchanger even more: $21,149 for the non-exchanger, $34,790 for the exchanger. ($59,820 in Available Capital for the non-exchanger versus $79,321 for the exchanger.)

You can start to see the impact that deferral of taxes has on one's investment potential. Looking at the next section of the spreadsheet will drive the point home:

Comments: It is not uncommon to see the Net Profits double after only three periods based on reasonable assumptions. They don't quite double using my assumptions, but I'd still rather be moving into the fourth property with almost $62,000 in profits versus only $32,714. You can follow through the fourth period and see the Power of the Section 1031 Tax-Deferred Exchange!

I will be happy to email this spreadsheet to you for you to experiment with. If you'd prefer not to post your email address in the comments section, go to our website (Iowa Equity Exchange) and click on the "Contact Us" link. Send an email to the email address on that page and we will promptly send you the spreadsheet. I hope it's helpful to you and that you'll have some fun with it.

****

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange

Ken Tharp

800-805-1031 toll free

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY. PRECISION. SECURITY.

Copyright © 2009 By Ken Tharp, All Rights Reserved. * The Power of the Section 1031 Tax-Deferred Exchange - Free Spreadsheet * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.