Why a 1031 Exchange is a Wealth Building Tool! - Northwest Atlanta Properties

Why a 1031 Exchange is a Wealth Building Tool!

From Your Friends at Northwest Atlanta Properties

Top 9 Reasons to 1031 Exchange

*Consult your tax professional for your personal situation

Consider two investments. Each was purchased for $200,000, held for 28 years and is fully depreciated. Each property is worth $800,000 today. Each net $3000 a month after taxes, management fees and insurance.

Property #1 Owner decides to sell and pays the federal capital gains tax of 15% and is in a state with a 7% capital gains rate and depreciation recapture. The net on the sale after all expenses is $500,000.

Property #1 Owner reinvests in two newer $250,000 properties that are newer and together net $3,200 a month after expenses. Success! Newer homes, less maintenance concerns, and they are making more money each month.

Property #2 Owner also sells and conducts a 1031 Tax Deferred Exchange. Because they defer taxes, the sale nets $750,000 with the deferral of federal and state capital gains taxes and depreciation recapture.

Property #2 Owner is able to exchange into (i.e.: purchase) three newer $250,000 properties and nets $4,800 in income each month. This is even better success, more income, and they’ll build more wealth.

If over the next 10 years all of the $250,000 properties appreciate 20% Property Owner #1 now owns $600,000 worth of real estate and Property Owner #2 owns $900,000 worth.

If you’d like us to evaluate the potential benefits of a 1031 exchange for your property let me know at 770-726-1454 or email us at mike.stott@mac.com

Here are 9 of the of the top reasons to conduct a 1031 exchange.

For our layman’s report and more details on 1031 exchanges click here.

Reason #9 – To consolidate or diversify real estate investments.

By selling multiple properties and buying one larger replacement property, you lessen management responsibilities and may also be able to geographically consolidate property. For those investors who own one larger property, exchanging can allow them to sell and diversify into other types or locations without having to pay any tax.

Reason #8 – To pull equity out tax-free by reinvesting > refinancing.

One of the primary advantages of a 1031 exchange is not having to pay tax that otherwise might be due. One disadvantage is that all of the proceeds must be reinvested in the new property to defer all taxes. Investors can convert their equity into cash by completing the exchange– using little or no leverage on the replacement acquisition– and then subsequently in the future (check with tax consultant on how long in the future) refinancing the replacement property. The refinancing proceeds are not taxable.

Reason #7 – To change your real estate investment to a different asset class.

There are times one particular asset class, like office, may be on a long-term downward trend. Exchanging can allow an investor to move out of office property into another type of property that may be on the rise.

Reason #6 – To transfer a greater amount of wealth to your children through a step up in basis.

When you sell highly appreciated property later in life, it lessens the value of your estate because of the tax that was paid. It also fails to capitalize on the principle of compounding. A 1031 exchange is the perfect tool to maximize the value of your estate and build greater wealth for your heirs. Additionally, upon your death, your heirs may receive a step-up in basis, so tax may never be owed. Check with your tax consultant.

Reason #5 – To upgrade the quality or return on your current investment.

Sometimes a property doesn’t perform as expected or the return starts to decline as the property or area ages. Selling the underperforming asset and replacing it with a property that has a better anticipated yield can make a huge difference. Many investors do this routinely to always own something newer and more desirable to high quality tenants.

Reason #4 – To move your property from one geographic location to another.

For investors who are moving to a different state and want to take their investment property along, a 1031 can help accomplish that goal. Some investors see an area they’d like own in and 1031 Exchange into that area vs buying another investment there. Other investors may be tired of the long miles between three different rental houses they personally manage and want an easier trek. Through a 1031, they can sell the properties they own and buy property in a location that better suits their current lifestyle.

Reason #3 – To sell management intensive property and buy more of a passive investment type property.

For the investor who personally manages rental homes, or other multi-tenant property, the thought of owning a larger, professionally managed investment can be very attractive. Using a 1031, they can eliminate management headaches by exchanging into a triple-net leased property where the tenant takes care of everything or into a fractional interest in a larger commercial property that is being professionally managed. DST exchanges are becoming popular but also have drawbacks. Ask us for help on this and read this article.

Reason #2 – To convert land into income-producing property that also provides a depreciation deduction.

While land can be a very good investment, it usually does not produce cash flow. If you need or just prefer income, an exchange will allow you to trade into income-producing property deferring the tax using the 1031 Exchange. With this strategy, investors also gain a depreciable asset that will provide a tax shelter for some, if not all, of their rental income.

Reason #1 – To build much greater wealth through better and better properties, compounding, time, and leverage.

See the example above! Exchanging allows you to keep all of your money working for you— not only now— but most importantly, into the future. There is a reason that Einstein said that compounding is the most powerful force in the universe. It has made many a millionaire. Exchanging allows you to keep your equity working for you into the future.

Our Market Report

The snapshot of “Year over Year Price” remarkably shows that our areas of business actually increased in value almost 3%!

This excluded Alpharetta which had a fluke of expensive properties – 21 of 70 sales in April closed over $1,000,000 and up to $3,200,000 closing (which is sometimes a problem with statistics in general. They are snapshots not trends.)

The number of sales dropped from 1039 to 811 (22% fewer closings) primarily due to a lack of inventory to sell! Our market is strong for well-priced homes which means more money that last year but not “crazy more.”

Property Management Questions we hear lately:

We now manage about 80 rentals and often see owners gifting lower rent to their long-term renters. While this may be considered being nice, we recently met with an owner who will sell their property and discovered that they had been under charging rent by at least $700 a month. Effectively gifting $8,400 a year to their tenant. Just as if she paid market rent and they gave her a check each year for that amount…

Rents have risen dramatically over the past 5 years. Call us for a no-obligation professional analysis for your rental property. We have seen the rents “Cap Out” recently with aggressive increases being scaled back to get a vacant home rented. The chart below shows that rent shave remained relatively float for the past 18 months after rising dramatically for the previous 4 to 5 years.

That being said we are often asked how much have rents risen?

About 5% a year since 2020 however as mentioned about we may have hit a ceiling. See this report for an educated guess.

The second question we are asked about weekly is: Can we buy a bargain? Can you show us foreclosures/HUD owned homes?

We wish While foreclosures filings more than doubled in 2022 the number of foreclosures filed was down 34% from pre-pandemic levels. Most of this increase was caused by an end to the moratorium of filings. In other words, properties that would have foreclosed in 2020-2021 caught up in 2022. Averaging the 3 years, all were historic lows. In fact, 93% of homeowners who have a foreclosure notice filed have positive equity which they can use to refinance or sell their homes and avoid foreclosure sale. We just do not see foreclosures rising unless and until prices fall.

Plus, with the inventory for sale at historic lows each home with a foreclosure filing is receiving 20 to 50 offers to assist them in selling the home.

Georgia has a filing rate of .26% -with roughly 4.4 million homes of which about half have a mortgage so 2.2 million homes – or 5720 foreclosure notices filed.

With only a 7% upside-down rate that means we may see 300-600 homes foreclosed upon or under 50 a month for the entire state.

With lots of professional investors trying to buy these properties before they foreclose, we will not have many – if any – foreclosures to sell to our smart investor clients.

We continue to appreciate your business and referrals to us,

Mike Stott, Jon Burke, and Donna Stott