You may be thinking "why in the world would I even need a 1031 Tax Deferred Exchange if I'm losing my rental property through a short sale transaction?"
The answer to that question is very easy, but may surprise many investors who are going through a short sale, foreclosure or deed-in-lieu of foreclosure transaction themselves.
Short Sale Scenario
Our story begins with a real estate investor who has been buying and holding investment properties for the last five (5) years. The real estate investor refinances all of their investment properties about once every six to twelve months depending on how much they have increased in value in order to pull out the cash equity in the property and acquire more rental properties. He or she maintains the loan-to-value ratio as close (as high) to 100% as possible. It was easy to do so with the easy credit markets.
Now, of course, the real estate markets have gone through a free fall and probably have a little bit more to drop. The real estate investor's total market value of his or her real estate portfolio has plunged significantly below what is owed on the portfolio. Renters have been and may continue to move out and rental income drops to below costs, expenses and debt service. The investor is no longer able to service the debt servicing requirements because the cash flow has dropped so much.
They have no choice but to sell the property and complete a short-sale, unless they want to lose the property through a foreclosure (trustee's) sale.
Capital Gains
Let's say the real estate investor bought the real property for $100,000.00 (original cost basis) and that the real property progressively increased in value over the years to $500,000.00 (fair market value). The real estate investor was able to refinance over and over again and now has total outstanding debt of $450,000.00 (90% loan-to-value ratio).
The investment property market value has now dropped to $300,000.00. The real estate investor owes $150,000 more than what the real property is actually worth on the market today, so he or she decides that their ownly alternative is to sell the real estate for $300,000.00 and complete a short-sale.
Here's The Catch
The real estate investor sells the property for $300,000.00, but he or she has a $100,000.00 cost basis, which translates into a $200,000.00 CAPITAL GAIN.
They are still going to owe capital gain taxes on the $200,000 capital gain (profit) even though they have sold the real property and have NO EQUITY in the real estate. Investors often get equity and capital gain or profit confused.
ZERO EQUITY 1031 EXCHANGE™
There is a possible solution, which is to defer the payment of the real estate investor's depreciation recapture taxes and capital gain taxes by structuring and completing a Zero Equity 1031 Exchange™ (the phrase was coined and trademarked by Exeter 1031 Exchange Services, LLC in April 2009).
The Structure Is Actually Quite Easy
It works like any other 1031 Tax Deferred Exchange transaction except that the real estate investor has no equity or cash position left in the real estate in order to structure the 1031 Tax Deferred Exchange. There is no cash proceeds for the 1031 Tax Deferred Exchange Qualified Intermediary to receive and hold as part of the 1031 Exchange transaction.
The challenge for the real estate investor is to find a way to acquire and finance like-kind replacement property as part of the 1031 Tax Deferred Exchange. Structuring the Zero Equity 1031 Exchange is the easy party, but locating and buying suitable replacement property as part of the Zero Equity 1031 Exchange is the near impossible part.
The answer to that question is very easy, but may surprise many investors who are going through a short sale, foreclosure or deed-in-lieu of foreclosure transaction themselves.
Short Sale Scenario
Our story begins with a real estate investor who has been buying and holding investment properties for the last five (5) years. The real estate investor refinances all of their investment properties about once every six to twelve months depending on how much they have increased in value in order to pull out the cash equity in the property and acquire more rental properties. He or she maintains the loan-to-value ratio as close (as high) to 100% as possible. It was easy to do so with the easy credit markets.
Now, of course, the real estate markets have gone through a free fall and probably have a little bit more to drop. The real estate investor's total market value of his or her real estate portfolio has plunged significantly below what is owed on the portfolio. Renters have been and may continue to move out and rental income drops to below costs, expenses and debt service. The investor is no longer able to service the debt servicing requirements because the cash flow has dropped so much.
They have no choice but to sell the property and complete a short-sale, unless they want to lose the property through a foreclosure (trustee's) sale.
Capital Gains
Let's say the real estate investor bought the real property for $100,000.00 (original cost basis) and that the real property progressively increased in value over the years to $500,000.00 (fair market value). The real estate investor was able to refinance over and over again and now has total outstanding debt of $450,000.00 (90% loan-to-value ratio).
The investment property market value has now dropped to $300,000.00. The real estate investor owes $150,000 more than what the real property is actually worth on the market today, so he or she decides that their ownly alternative is to sell the real estate for $300,000.00 and complete a short-sale.
Here's The Catch
The real estate investor sells the property for $300,000.00, but he or she has a $100,000.00 cost basis, which translates into a $200,000.00 CAPITAL GAIN.
They are still going to owe capital gain taxes on the $200,000 capital gain (profit) even though they have sold the real property and have NO EQUITY in the real estate. Investors often get equity and capital gain or profit confused.
ZERO EQUITY 1031 EXCHANGE™
There is a possible solution, which is to defer the payment of the real estate investor's depreciation recapture taxes and capital gain taxes by structuring and completing a Zero Equity 1031 Exchange™ (the phrase was coined and trademarked by Exeter 1031 Exchange Services, LLC in April 2009).
The Structure Is Actually Quite Easy
It works like any other 1031 Tax Deferred Exchange transaction except that the real estate investor has no equity or cash position left in the real estate in order to structure the 1031 Tax Deferred Exchange. There is no cash proceeds for the 1031 Tax Deferred Exchange Qualified Intermediary to receive and hold as part of the 1031 Exchange transaction.
The challenge for the real estate investor is to find a way to acquire and finance like-kind replacement property as part of the 1031 Tax Deferred Exchange. Structuring the Zero Equity 1031 Exchange is the easy party, but locating and buying suitable replacement property as part of the Zero Equity 1031 Exchange is the near impossible part.
However, the Zero Equity 1031 Exchange does allow the real estate investor to sell his or her troubled investment property, complete a short-sale AND structure a 1031 Tax Deferred Exchange in order to defer the payment of the capital gain taxes.
It works well with transactions structured pursuant to a deed-in-lieu of foreclosure, too. It gets a little more complicated when you are going to actually lose the property through a foreclosure. You can contact me for assistance. I would be happy to discuss this in greater detail with you.
Posts
No comments:
Post a Comment