Written by Michele Fitzpatrick. Originally published in the New England Real Estate Journal.
Good journalists know that in order to communicate information
effectively, they have to answer the who, what, where, when, why and how
questions in the first sentence of their article. So many of my recent
articles and social media posts have focused on who can utilize a 1031 Exchange, what types of properties qualify, when is the best time to exchange and most often, how the process works. However, it is equally as important to understand WHY investors exchange, so you can better determine if an exchange is right for your business and how you can benefit.
Here are some of the more common reasons why our real estate investor clients utilize 1031 Exchange:
Investment properties make up a large percentage of our clients’
assets, which will need to be considered when creating their estate
plans. Many clients are faced with situations where their heirs may not
want to or are not able to manage a particular investment property, and
the inheritance becomes a burden. Investors may utilize 1031 Exchange to
acquire multiple properties for each heir, smaller more manageable
properties in more desirable locations or opt for a vacation rental in a
retirement community for future use.
Diversification: Often, in conjunction with estate
planning, investors plan to diversify their asset. They may have one
large multi-family or commercial property and choose to purchase
multiple smaller properties. This is beneficial when dividing assets for
estate planning, or as a strategy to slowly ease out of investment real
Consolidation: On the flip side, clients who have
many years left to invest may be in the position to consolidate their
multiple properties into one larger multi-family or commercial property.
This often alleviates management burdens, consolidates bills and
improves cash flow.
Increased Depreciation: The IRS allows an investor
to depreciate a residential investment property over 27.5 years, and a
non-residential property for 39 years. If the value of the investor’s
property has significantly increased as it approaches the end of its
depreciation lifecycle, it can be a powerful tax strategy to utilize
1031 Exchange and purchase a new appreciated asset. The depreciation
clock can start over again on the excess basis (or the profit). This
will ultimately increase cash flow in the new property. It is important
to talk with a tax advisor to explore this option in greater detail.
Cash Flow: So often investors are looking to
increase their cash flow, but location, property condition, property
size, city taxes and utility fees are hindering their income. Some
examples of how clients have increased their cash flow:
- Vacation rentals in a desirable spot that commands top nightly and weekly rents.
- Avoid Condos with high HOA fees that offer little amenities or return.
- NNN commercial properties where tenant is responsible for all expenses.
- Location, Location, Location. Focus on desirable neighborhoods that drive higher rents.
Management Relief: If anyone has been a landlord
before, you understand the feeling you get when the phone rings in the
middle of the night; tenant with no heat or a burst water pipe. Many
seasoned landlords don’t want these management headaches forever. 1031
Exchange can help these landlords find a more suitable property to
alleviate this stress. Often times this can be achieved by exchanging
the troublesome property for a property that is newer or newly
renovated, a condo with a management company, a vacation property with a
rental and management company, a Delaware Statutory Trust or a NNN
commercial property. These are just a few of the possibilities to
explore to alleviate this burden.
Leverage: As I stated above, real property is
often the biggest asset people own. In the Boston area, properties have
continued to increase in value and these investors have equity tied up
in their investments. By exchanging and buying up in value, utilizing
the equity and borrowing funds, savvy investors will increase their net
worth and have highly valued properties in desirable locations.
Although it is so important to understand how 1031 Exchange works, it
is more important to understand why it will work for you. Now that
you’ve read through all the “Why’s,” it’s a good time to consider your
property and your situation to see if there’s anything about your real
estate investment and overall strategy you want to change, and how 1031
Exchange can help.
Contact Michele Fitzpatrick today at 781-569-1852 or MFitzpatrick@nbtc.com with any questions regarding 1031 Exchange.