Real estate investment portfolios should be reviewed periodically. Why? Because as the real estate market changes, new opportunities become available and financial objectives shift. Depending on your circumstances, it may be fortuitous to reposition a portfolio utilizing a 1031 Exchange. A quick five point analysis can help determine if a 1031 Exchange makes sense for you/your client.
For example, an investor owns an apartment building currently valued at $1.8M. It was purchased for $100,000 in 1975. Clearly, this was a great investment as the property has appreciated significantly and is now worth eighteen times what it was in 1975. But, like all investments, one should analyze whether it is now better to hold or to sell the asset. Let’s do a quick five point analysis.
The apartment building is currently owned free and clear of debt. It has been owned for more than 27.5 years, so it is fully depreciated and no longer eligible for annual depreciation deductions on the investor’s tax return. Reviewing the cash-flow, after property taxes, maintenance, and insurance, it produces net rental income of about $3,000 per month. Income of $36,000 per year on an investment property worth $1.8M amounts to only a 2% annual return on the investment. However, the original $100,000 investment has grown by 1800% and there is now $1.8 million worth of equity tied up in one asset.
With interest rates at historic lows, unlocking some of that equity and exchanging, tax deferred, into one or more properties with greater income and long-term appreciation potential could be a valuable benefit. In the apartment example, the five point analysis shows repositioning a real estate portfolio through 1031 Exchange makes sense for this investment real estate. Better appreciation, maximized depreciation, increased cash-flow, investment diversification and tax deferral are all important drivers for utilizing a 1031 Exchange.
Through a 1031 Exchange, this real estate investor can sell the investment property and accomplish a number of tax and investment goals. A 1031 tax deferred exchange permits the investor to defer federal capital gains tax, depreciation recapture tax, investment income tax imposed by the Affordable Health Care Act and state tax. The investor can buy property with improved cash-flow, and if encumbered it will provide an interest deduction. If the replacement property is greater in value than the relinquished apartment building, then depreciation deductions will also be available for the increased basis (the difference between the purchase price of the new property and the sale price of the old property). Additionally, because multiple properties can be acquired through a single exchange, the investor can diversify the real estate portfolio, thereby hedging the investment risk inherent in a single property.
If repositioning a real estate portfolio is in order, the valuable tax benefits of a 1031 Exchange should definitely be considered. Take the time to review your investment real estate portfolio today.
For more information about buying and selling investment property please contact me.
Source: Investment Property Exchange Services. http://www.ipx1031.com/