The key to increasing profits when investing in real estate is not only to maximize cash inflows, but also to manage cash outflows. In particular, I am referring to tax liability. In 1921, Congress enacted the like-kind exchange statute, often called a 1031 Exchange. Two of the primary purposes of this legislation were: 1) to avoid unfair taxation of ongoing investments in property and 2) to encourage active reinvestment. The statute allows for like-kind exchanges of property to permit taxpayers to maintain investments in real property without being taxed on theoretical (i.e. “paper”) gains and losses during the course of a continuous investment.
Congress explained:
In other words, profit or loss is recognized in the case of exchanges of notes or securities, which are essentially like money; or in the case of stock in trade; or in case the taxpayer exchanges the property comprising his original investment for a different kind of property; but if a taxpayer’s money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit. The calculation of the profit or loss is deferred until it is realized in cash, marketable securities, or other property not of the same kind having a fair market value.
Having the ability to leverage this legislation to limit tax liability can be of significant value to a real estate investor. However, one of the significant challenges in managing tax liability by using a 1031 Exchange is timing. Often when the timing is right to sell a real estate holding, it may not coincide with the ability to reinvest quickly in another property. The issue of timing becomes a challenge because of the limitations set forth by the like kind exchange legislation. Specifically, the first limit is that an investor has 45 days from the date they sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by the investor, and delivered to a person involved in the exchange such as a qualified intermediary. The second limitation is that the replacement property must be purchased and the exchange completed no later than 180 days after the sale of the exchanged property.
Given an investor has only 45 days to identify a replacement property, they in essence need to have a property identified before they sell the relinquished property. Great replacement investment properties are not always readily available and therefore investors may often have to accept replacement properties that may only represent marginal investment opportunities in order to meet the timing limitations.
This is where Urban Core Advisors come in. At Urban Core Advisors, we are constantly reviewing new investment opportunities and we maintain a pipeline of new projects for our investors to be involved in. Given this, we have been able to help our clients defer tax liability by way of a 1031 Exchange and have access to replacement properties without having to sacrifice quality for the sake of timing. We encourage all real estate investors to contact us when they are thinking of using a 1031 Exchange and to let us help them find high quality replacement properties.
Our investment team does ongoing market research and site analysis to determine the best locations geared towards our investment strategy.
We perform site inspections and consult with general contractors and architects to identify property improvement opportunities and cost estimates.
We do extensive property analysis including underwriting property historical cash flow, three tiered income modeling, future cash flow projections and IRR and cash on cash return profitability models.
Our team underwrites the current tenants and reviews all current lease agreements to determine an appropriate credit grade of the property and identify opportunities for improvement.
