Great News for Landlords

Apartment Vacancies Decline in U.S. to Lowest Rate Since 2001

Apartment vacancies in the U.S. fell to their lowest level since 2001 as home seizures and a growing pool of young adults forming households boosted rental demand, according to Reis Inc. (REIS)

The vacancy rate fell to 4.9 percent in the first quarter from 6.2 percent a year earlier, the New York-based property- research company said in a report today. It was only the third time since Reis began gathering the data 31 years ago that the rate was less than 5 percent.

When vacancies drop below 5 percent, “effective rents tend to spike as landlords perceive that tight market conditions allow for greater pricing power,” Reis said in the report.

Effective rents, which take into account such landlord concessions as a free month, climbed almost 1 percent from the previous quarter to an average $1,018, the largest increase since the last recession began, according to Reis.

FIVE REASONS TO EXCHANGE: INVESTORS CAN MEET MANY OBJECTIVES UNDER IRC §1031

Section 1031 tax deferred exchanges continue to increase in popularity as more investors nationwide discover the wide range of investment objectives that can be easily met through exchanging.

I. PRESERVATION OF EQUITY

A properly structured exchange provides real estate investors with the opportunity to defer 100% of both Federal and State capital gain taxes. This essentially equals an interest-free, no-term loan on taxes due until the property is sold for cash! Often the capital gain taxes are deferred indefinitely because many investors continue to exchange from one property to the next, dramatically increasing the value of their real estate investments with each exchange!

II. LEVERAGE

Many investors exchange from a property where they have a high equity position, or one that is “free and clear”, into a much more valuable property. A larger property produces more cash flow and provides greater depreciation benefits, which therefore increase the investors’ return on their investment.

III. DIVERSIFICATION

Exchangers have a number of opportunities for diversification through exchanges. One option is to diversify into another geographic region, such as exchanging out of one apartment building in Denver, Colorado, for two additional apartments – one in Los Angeles, California, and the other in Dallas, Texas. Another diversification alternative is acquiring a different property type, such as exchanging from several residential units to a small retail strip center.

IV. Management Relief

Some investors accumulate several single family rentals over the years. The on-going maintenance and management of what can be a far-reaching group of properties can be lessened by exchanging these properties for one property better suited to on-site maintenance and management. Exchanging into a single apartment complex with a resident manager is a good example of this strategy.

V. ESTATE PLANNING

Sometimes a number of family members inherit one large property and disagree about what they want to do with it. Some want to continue holding the investment and some desire to sell it immediately for cash. By exchanging from one large property into several smaller properties, an investor can designate that, after their death, each heir will receive a different property, which they can either hold or sell.

Call the knowledgeable exchange professionals at Asset Preservation for a complimentary consultation regarding your specific investment objectives.

FARM AND RANCH EXCHANGES: OPPORTUNITIES ABOUND WHEN SELLING RURAL REAL ESTATE

 

 

Section 1031 of the Internal Revenue Code permits real and personal property that is “held for productive use in a trade or business” or “held for investment” to be exchanged for other “like-kind” property while deferring capital gains and recapture taxes that would otherwise result from the sale of a property. In the context of real property, the definition of “like-kind” is so broad that almost any perpetual interest in real property of any type will be treated as like kind to any other perpetual real property interest. Consequently, one is not limited to an exchange of a ranch for another ranch or a farm for another farm. Instead, a farm can be exchanged for a commercial office property, a residential rental property or even raw land. Finally, a sale of a farm or ranch often consists of selling real and personal property. As discussed below, both may qualify for deferral in a 1031 exchange.

REAL PROPERTY

Real property held for productive use in a trade or business or for investment can be exchanged for any like-kind real property to be held for either investment or for productive use in a trade or business. When dealing with the sale of a farm or ranch, the most obvious form of qualifying real property is the actual acreage. However, land used as a farm or ranch can present additional 1031 exchange opportunities. For example:

1. In states where water rights are considered to be real property, many farmers and ranchers are exchanging their rural water rights to acquire income producing real estate, thereby increasing cash flow and reaping tax benefits from depreciation deductions.

2. Mineral rights may provide another 1031 exchange planning opportunity.

3. Some rural property owners are conveying conservation easements on their land to acquire more productive property through an exchange.

4. A 1031 exchange has been extremely useful in the granting of an agricultural easement in exchange for fee simple title in different property.

5. Easements for cell towers can also qualify for a 1031 tax deferral treatment.

6. Mitigation credits for restoring wetland property may be exchanged for other mitigation credits.

A seller of a farm or ranch may be able to take advantage of two different tax code sections to minimize capital gain tax liabilities on the sale of real property. Under IRC §121, for example, farm and ranch sellers can often qualify for a tax exclusion on the primary residence portion of their property, while most or all of the remainder of the property can qualify for tax deferral under IRC §1031. IRC §121 allows a property owner to exclude capital gain taxes if the home was their primary residence for two (2) of the last five (5) years. Couples filing a joint tax return can exclude up to $500,000 of the capital gain on the sale of their principal residence while single filers can exclude up to $250,000.

PERSONAL PROPERTY AND LIVESTOCK

Section 1031 permits personal property held for investment or used in a business to be exchanged for other similar personal property that is in either the same General Asset Class or the same Product Class. Many farm and ranch sales include significant irrigation equipment, farm machinery and tractors. The IRS has established 13 General Asset Classes along with a more detailed description of Product Classes, which are specified in the North American Industry Classification System (NAICS).

Livestock held for investment may also be exchanged, although livestock held primarily for sale would not qualify. Furthermore, IRC §1031 states that livestock of different sexes are not like-kind property. Most tax advisors believe breeding livestock that are not held primarily for sale can be exchanged. Although a bright line standard regarding exchangeable livestock does not currently exist, some tax advisors are of the opinion that a purebred registered beef cow may be like-kind to a grade beef cow because they differ only in quality or grade. On the other hand, a dairy cow might not be considered like-kind to a beef cow because they represent two different types of livestock. As always, review all aspects of any proposed farm or ranch exchange with a competent tax and/or legal advisor along with a reputable leading national exchange qualified intermediary, Asset Preservation, Inc.

EXCHANGE ENTITIES: CONSIDER THESE VESTING ISSUES PRIOR TO A §1031 EXCHANGE

Generally in a §1031 tax deferred exchange, an Exchanger should take title to the replacement property in the same manner they held title on the relinquished property. In most cases, the entity initiating the exchange must be the same entity concluding the exchange. Some examples are reflected below:

· If a wife relinquishes, then the wife acquires;

· Smith LLC relinquishes, Smith LLC acquires;

· Gemco Corp. relinquishes, Gemco Corp. acquires;

· Durst Partnership relinquishes, Durst Partnership acquires.

Some Exceptions to the General Rule

Partnerships and Limited Liability Companies (LLC’s): An Exchanger who elects taxation as a sole proprietorship can hold the relinquished property as an individual but acquire the replacement property as a single-member, single-asset LLC.  This provides the benefit of liability protection and also can help satisfy the ‘single asset entity’ requirements that many lenders impose on replacement property purchases.  The IRS has also ruled that a limited liability company with two members will be considered a single member limited liability company if the sole role of one of the members is to prevent the other member from placing the LLC into bankruptcy and that the limited role member had no interest in LLC profits or losses nor any management rights other than the limited right regarding bankruptcy.

Grantor Trusts: An Exchanger can acquire a replacement property in a revocable living trust or “grantor” trust for estate planning purposes.

Death of an Exchanger: If the Exchanger dies during the exchange, the deceased Exchanger’s estate may complete the exchange.

BUSINESS CONSIDERATION/LENDER REQUIREMENTS

Sometimes a business consideration, lender requirement or the Exchanger’s liability issues can make it difficult to keep the vesting entity the same throughout the exchange. For this reason, it is important that Exchangers review the entire exchange transaction with their legal and/or tax advisors before closing on the sale of the relinquished property. Some problem areas:

If a wife, as the only Exchanger, is relying on the husband’s income to qualify for replacement property financing, the lender may require that the husband appear on the deed. This could have an impact on the wife’s exchange.

Most lenders are wary about lending to trustees. An Exchanger who relinquishes property in a trust but needs to obtain conventional financing for the purchase may have difficulty obtaining a loan because lenders prefer loaning to an individual.

Sometimes an Exchanger may relinquish a property in one entity such as multi-member LLC, corporation or partnership but want to acquire a replacement property in a different entity. This would disqualify the exchange.

Commercial Real Estate Returns for the Past 10 Years -- 117 Percent Combined Operating Profits and Property Value Change in a Decade

The National Council of Real Estate Investment Fiduciaries (NCREIF) http://www.ncreif.org/about.aspx  is a non-profit  trade association for pension funds and other tax-exempt investors in real estate created to aggregate and report accurate, unbiased real estate return data. 

One of the many data series they provide is the NCREIF Property Returns Index reporting quarterly performance in both property value and operating income for  more than 6,800 commercial properties having a combined value in excess of $283 billion.  A description of the index and the quarterly can be found http://www.ncreif.org/property-index-returns.aspx  This series is perhaps the best proxy for U.S. commercial real estate performance.

In the past 10 years, average annual return of the index was 7.73 percent, with a combined 13.56 percent total return (property value change and operating income) in 2011.  While some of the properties are leveraged using debt, the index is calculated as if all properties were unlevered. 

Commercial real estate was one of the top investment performers in 2011.  In the past decade, the total return was more than 117 percent—a more than doubling of the original investment.  

For a look at all of the NCREIF data series (including timberland) click  http://www.ncreif.org/data.aspx

Good News about Real Estate Market

Good news from Dr. Ted Jones:

The National Association of Realtors® reported February 2012 homes sales of 4.59 million on a seasonally-adjusted annualized rate—a gain of 8.8 percent when compared to February 2011.  That’s really good news for the housing market since home prices typically follow the trajectory of sales numbers, although lagging 18 to 24 months.   

To remove the seasonality noise from the data, the following table shows a 12-month moving average of existing home sales.  Focus on the rising sales numbers in the red circle and realize that the market indeed is recovering.  Existing home sales on a 12-month moving average basis have now increased in six of the past seven months. 

Home values may have finally stabilized, after declining almost 27 percent from the peak in July 2006.  This now makes three months that prices (on a 12 month moving average) have remained static.  I am calling a bottom to the housing market at this time.

While home sales and prices are far off of the 2002 levels (which I consider normal given that period was following the 2001 recession and prior to the stupidity of subprime lending which caused the bubble), sales numbers are finally increasing and prices have stabilized.  I truly believe that housing has turned the corner to recovery—and that is great news.

To read the entire NAR press release, click: http://www.realtor.org/press_room/news_releases/2012/03/ehs_feb

Ted C. Jones, Ph.D.
Senior Vice President-Chief Economist, Stewart Title Guaranty Company
Director of Investor Relations, Stewart Information Services Corporation NYSE-STC

DEPOSITS IN AN EXCHANGE: HANDLING EARNEST MONEY DEPOSITS IN AN EXCHANGE

Most offers to purchase real estate are accompanied by the Buyer’s delivery of a check to the Seller generally referred to as an “Earnest Money Deposit”.  Depending on the terms of the purchase agreement, the earnest money deposit may be refundable or non-refundable.  In most cases, the delivery of the earnest money deposit is refundable and merely serves as evidence of the Buyer’s intent to purchase a property.

In a tax deferred exchange under Internal Revenue Code Section 1031, however, the Seller (Exchanger) is generally prohibited from receiving the proceeds from the sale of the relinquished property.  An Exchanger receives sale proceeds if “. . . the taxpayer actually receives the money or property or receives the economic benefit of the money or property.  The taxpayer is in constructive receipt of money or property at the time the money or property is credited to the taxpayer's account, set apart for the taxpayer, or otherwise  made available so that the taxpayer may draw upon it at any time or so that the taxpayer can draw upon it if notice of intention to draw is given.”

As a result of the foregoing rules, Exchangers are rightfully concerned about the tax consequences resulting from their receipt of an earnest money deposit or the payment of an earnest money deposit to a Seller in connection with the acquisition of replacement property. Some of the typical questions that Asset Preservation receives are discussed below:

If a Seller of an investment property is planning to engage in a §1031 tax deferred exchange, can  the Seller accept an earnest money deposit and still obtain full tax deferral?  The answer is usually, yes.  First, the question of whether the Exchanger is in receipt of the sale proceeds is determined at the time ownership is transferred from the seller to the buyer (usually referred to as the “closing”).  Thus, if the Exchanger enters into a qualified exchange agreement before the closing as required when engaging in a tax deferred exchange, and thereafter deposits the earnest money funds with the Qualified Intermediary or the Closing Agent before the closing occurs, the receipt of the earnest money deposit should not be treated as the receipt of the sale proceeds.  On the other hand, if the Exchanger keeps the earnest money deposit through the closing, he or she would be in receipt of proceeds from the sale. In this case, the deposit would constitute boot in the exchange, thus would be taxable to the extent there is a capital gain.

Can an Exchanger pay an earnest money deposit to a Seller of replacement property?  Yes. There are two ways to accomplish this within a tax deferred exchange. If the Qualified Intermediary is holding exchange funds from the sale of the Exchanger’s relinquished property, the deposit can be wire transferred directly to the Closing Agent or Seller for the Exchanger after the replacement property exchange agreement has been fully executed by the Exchanger. Alternatively, the Exchanger can pay the earnest money directly to the Closing Agent or Seller from their own funds and get reimbursed their deposit at the closing without creating a taxable event.  The Exchanger may enter into contract on the replacement property before entering into contract on their relinquished property, but it is important to close on the relinquished property prior to purchasing the replacement property in order to avoid a "Reverse Exchange" situation. 

Can an Exchanger get reimbursed for their earnest money deposit paid for the replacement property?  Yes. Assuming that the Exchanger has paid the earnest money deposit from their own funds, the Qualified Intermediary may direct the closing agent to include an item on the closing statement evidencing the return of earnest money funds to the buyer such as “Refund of Earnest Money to Buyer”. The Qualified Intermediary would then transfer funds to the closing agent in an amount sufficient to reimburse the Exchanger.