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Why Now is a Great Time For a 1031 Exchange

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Commentary by Steve Rodgers and Jon Ryan

RISMEDIA, May 16, 2008-Any successful investor will tell you that the benefits of real estate investing are many: big profits, security and a historical track record of growth. The downsides, however, can be equally challenging. Investors who sell a real estate property face steep taxes that can cut deeply into potential profit, diminishing the appeal of such a transaction.

This is where a 1031 exchange becomes an appealing option. This unique transaction is based on Section 1031 of the Internal Revenue Code, which states “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for an investment.” In a 1031 Exchange, the seller does not receive the proceeds on the sale of an investment property; instead they are held by a third party qualified intermediary who then facilitates the transfer of the proceeds to another investment property as required by 1031. “The 1031 Exchange is a wonderful way that the IRS allows real estate investors to defer payment of capital gains tax on their investments,” said Jon Ryan, Senior V.P. of Western Region Sales for 1031 Exchange Advantage, Inc. “More than in many other markets, a high ratio of residential housing in Southern California is in fact investment property. This type of transaction has numerous benefits, and right now is proving to be a great time for it.” 1031 Exchange Advantage, Inc., a wholly-owned subsidiary of Vineyard National Bancorp, a 2.5 billion dollar institution listed on NASDAQ, is a nationwide provider of 1031 Exchange services and partners with Prudential California Realty to educate their real estate agents on the ins and outs of 1031 Exchanges, so clients and investors can exchange with confidence.

One of the biggest benefits of the 1031 Exchange is that by deferring the payment of capital gains tax on the sale of an investment property, the investor has much more cash to put toward the next property. 1031 Exchanges are not limited to residential properties; in fact they can be utilized in Multi-family developments; Home Office; Tenancy In Common; Triple Net Leases; Condo-Hotels; Oil and Gas property; Raw Land and Foreclosures. Prudential California Realty, one of the top five brokerages in the nation and a member of HomeServices of America Inc., a Berkshire Hathaway affiliate, attributes approximately 10% of their real estate transactions to 1031 Exchanges. “We are big proponents of the 1031 Exchange; so much so that we train our agents on it monthly,” said Steve Rodgers, President and CEO of Prudential California Realty. “The benefits are so important that we want all of our agents and clients to be fully versed in the concept.”

There are several variations of the 1031 Exchange that can accommodate investors in different situations. A Reverse 1031 Exchange is an arrangement where a new entity is introduced, known as an Exchange Accommodation Titleholder, or EAT. The EAT is a single-member LLC established by the Qualified Intermediary that takes title to a property for the investor until the relinquished property is sold. The investor must take title to the “parked” property from the EAT within 180 days in order for the transaction to qualify for 1031 Exchange tax benefits. This is known as the “Safe Harbor” offered by the IRS for real estate investors in this situation. Reverse Exchanges are specifically beneficial to investors who may find a property they would like to acquire before they have sold the current investment property. The Reverse 1031 Exchange allows these investors to potentially save thousands of dollars in capital gains tax.

The laws concerning 1031 Exchanges have been amended several times since the practice became commonplace. Most recently in 2005, investors gained new benefits through the introduction of Revenue Ruling 2005-14, which coupled section 1031 benefits with those of Section 121. This allows investors to exclude up to $250,000 (500,000 for joint returns) of the gain from the exchange of a property that qualified as their principal residence for at least two years and also acted as an investment property for at least the year prior to close of escrow.

Investors can exchange a former residence, and utilize both tax breaks, allowing them to pocket up to $250,000 ($500,000 for joint returns) through the section 121 tax exclusion and defer any remaining gain over the $250,000 limit ($500,000 for joint returns). It also allows investors to move into their exchange property after a period of time, then sell it as their residence if they owned it for at least five years.

“The IRS is providing these opportunities to investors, but not all are aware of the money they could be saving,” continued Ryan. “It’s not often that the IRS actually gives the chance to save thousands of dollars, and the process is very straightforward when you are working with a professional.”

1031 Exchanges also provide another unique benefit to investors through the Tenancy In Common (TIC) concept. This arrangement allows unrelated co-owners to each own an individual fee interest in a property. Tenancy In Common properties differ from the typical 1031 scenario because the properties are generally multi-family developments, retail centers, office buildings, shopping malls and other large commercial buildings with quality tenants already placed.

This scenario is a great option for exchangers who are looking to reduce involvement in the management of their properties, or who desire a larger building as an investment but are without the resources to do so as an individual.

No matter which variation of the 1031 Exchange is employed, partnering with an expert is a vital step that will save the investor the frustrations and headaches of going it alone. 1031 Exchanges are detailed and complex procedures with strict deadlines and tight time windows, and a professional can understand where you want to go and help you create that reality. Whether it is through your professional Realtor or a qualified intermediary, getting started on 1031 Exchanges is easier than you think, and the huge benefits in tax savings are waiting.

Steve Rodgers is President and CEO of Prudential California Realty (www.prudentialcal.com), one of the top five brokerages in the nation and a proud member of HomeServices of America Inc., a Berkshire Hathaway affiliate.

Jon Ryan is Senior Vice President Sales Western Region at 1031 Exchange Advantage, Inc. (www.1031exchangeadvantage.com), a wholly-owned subsidiary of Vineyard National Bancorp, a 2.5 billion dollar institution listed on NASDAQ.

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