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Any business that has a low barrier to entry or enjoys large profit margins has witnessed new competitors enter and challenge what was considered the norm. And some industries such as travel agencies have nearly become extinct.
The Internet hasn’t been the only cause of these changes~ new competition has forced oldline retailers and service companies to totally rethink who and what they are and to enter new areas to increase profits. Some companies are treading on areas that are completely outside their norm. Costco, for example, has entered both the real estate and banking industry. H&R Block, having conquered the tax return industry, is now using its muscle to crosssell new financial products to their current group of customers. WalMart has decided that banking will be a new and exciting area for them to conquer.
Consolidation and mergers are another factor. The trends that we have been seeing in corporate America are pointing to the next decade as being even more competitive, particularly within the real estate and financial services industries.. As this plays out it will become increasingly necessary for professionals in these industries to seek additional opportunities and sources of income to combat the reduced profit margins and cannibalization of customers that the competition will bring. The trends for the smaller professionals within the real estate and financial services industry point to (a) becoming specialists who works within a specific market niche or (b) adding new profit centers that complement what they already have in a bundled services approach. Whichever approach you choose (if you do choose any), the opportunities presented here will allow you to position yourself for three new income streams – 1031 Exchanges, Tenant in Common, and Zero Cash Flow –that can seamlessly blend into any type of real estate or financial services that you currently offer. These opportunities can be used either as new tools for your marketing or as stand alone profit centers that can easily net you hundreds of thousands (and in some cases millions of dollars) in professional service fees and commissions.
Included in the second part of this booklet are free and inexpensive proven marketing strategies that you can either apply to your current business or as a technique to integrate these new profit centers into your current business or finally to be used with these new profit centers to create an entirely new business model around. Either way that you choose to use them, these strategies will work for both immediate and longterm results.
1031 exchanges allow for the sale of any business or investment property, including raw land, without incurring any tax liability regardless of the size of the gain made on the sale.
That’s correct! You can show your clients how to sell their commercial property without paying any taxes! And since almost every state in America allows for a 1031 exchange, your clients can now avoid paying taxes to both the federal government and state as well.
By right, we should say “tax deferral” because an exchange doesn’t really let you escape taxes but just postpones the taxes due until you sell the property and take the cash from the sale.
But there are a number of techniques available which can provide a 1031 exchange to eliminate most or all of the taxes due from the sale forever. When we hear someone say an exchange is only a deferral and you eventually have to pay the taxes, we know that person has only a rudimentary knowledge about exchanges. This is an opportunity to win a new convert by explaining to them all the advantages –including the advanced ones that hardly anyone understands – that offer clients the opportunity to make the sale 100% tax free.
According to a recent Wall Street Journal report dated August 15, 2006, 1031 exchanges are surging in popularity even in a declining real estate market. As a matter of fact, 1031 exchanges have been the only bright spot in the real estate industry as of late.
Why are 1031 exchanges so popular, and why in a declining market are they surging in popularity? The answer is very simple. Although today’s tax rates are at their lowest in years, when both federal and state taxes are combined, it is very common to pay a full third of the selling price as taxes. Not only do you have to consider oth state and federal capital gain taxes, but don’t forget to add in other items like recapture and alternative minimum tax. With today’s high real estate prices and rapid appreciation that we have seen over the last decade, we are talking very large amounts of money in taxes that everyday people can avoid by using a 1031 exchange.
In any declining market, such as the one we have right now, more people will be trying to sell their property, thereby increasing the properties available for sale and putting additional pressure on prices. A soft real estate market may require some sellers to lower their prices an additional 15% to generate any interest. And any opportunity to save money by reducing expenses from the sale, especially income taxes, becomes more attractive and helps take the sting out of the lower prices.
There are many other factors contributing to the surge in 1031 exchanges. As you read through this report, you will see that the market has not even begun to be tapped. Demographic trends – aging baby boomers and growing number of immigrants owning real estate –will increase the popularity of 1031 exchanges, and when the real estate market finally recovers even more niches will exist for you to exploit.
The US Treasury Department introduced the idea of exchanges (although not as we do them today) in 1921 when they created IRS code section 202(c), which was later renamed to section 1031.
Many of today’s rules, including the introduction of the 45and 180day time requirements, were first introduced in 1984 when Congress adopted the Deficit Reduction Act. Eventually this paved the way for the final rulings and clarification of open exchange issues, which the Treasury Department completed and issued effective July 2, 1990. It was here that we had final clarification of the 45calendarday identification period and the 180calendarday exchange period. It also addressed some settled issues such as constructive receipt of proceeds from an exchange, creating what we now call the “safe harbor provisions” and made modifications to the exchange rules which disallowed partnership percentage of ownership interests from qualifying for a 1031 exchange.
It was the Tax Reform Act of 1986, though, that changed the real estate world forever and began what has been nothing less than an explosion in 1031 exchange transactions. The Tax Reform Act of 1986 eliminated what was considered by some to be preferential treatment of capital gains. In short, the Act removed the tax advantages of owning real estate, which generated losses by introducing the rules of passive loss limitations. Soon all the advantages of gains being taxed at a lower rate began to disappear, exposing sellers of real estate to tax rates and depreciation recapture at the highest rates, the same as ordinary income. 1031 exchanges remained the only tool still available at the time to escape these new higher rates.
The Department of the Treasury is still constantly reviewing and making slight modifications to section 1031. But it is now well entrenched and as it grows in both acceptance and understanding, it will continue to grow as a strategy to increase cash flows, shelter income, and become a tool for retirement planning. As new products that complement exchanges, such as tenant in common interests and zero cash flow properties, are introduced and coupled with advanced tax strategies such as cost segregation analysis, we will see the use of exchanges move from what is considered a specialty to become part of an everyday sale of investment real estate.
Exchanges are hotter than ever and continue to grow in popularity. According to the latest numbers released, 400,000 exchanges took place in the 2004 tax year, including individuals, partnerships, trusts and corporations who as taxpayers are all allowed to execute a 1031 exchange. Conservatively, the industry is projected to continue to grow at a rate of 5% per year over the next 10 years even in years of a down real estate market. All this is a result of more sellers of real estate learning about 1031 exchanges and those that do know about them discovering the even richer advantages that exchanging can offer them. Three of the largest trends expected to fuel the growth of exchanges are:
· Baby boomers starting to enter their retirement years· The increase of real estate ownership within the first generation immigrant market, and
· The migration of middleincome America from the northern states to the southern and western states.
At first glance, these statistics look very good . Exchanges seem to be well known and used commonly within the real estate industry. However, a recent study of the New England area between 20032004 produced startlingly different results than what early evidence lead us to believe.
A sampling of 182 owners of smaller investment real estate in Massachusetts and parts of southern New Hampshire and Northern Rhode Island revealed the following:· 24% had performed an 1031 exchange
· 22% had heard of an exchange but didn’t fully understand them · 54% had never heard of a 1031 exchange
· 22% percent of those who do an exchange, do another one within three years
How can it be that 54% of a market that is supposedly growing had not heard about an exchange? Who is it then that is causing the market to grow? The answer to these questions became obvious as the study revealed even more:
· The average age for an owner of investment property is 56 years old. · The average number of investment properties owned was three.
· 19% of the respondents were not born in the United States and had a primary
The most startling discovery of all though was that 48% of the owners sampled had no professional financial team. They had no regular accountant, attorney, or financial planner to assist them or explain to them what an exchange was and the advantages that it offered them.
Most of them used a franchise tax return preparer or did their own taxes. Many didn’t feel that their returns were complicated enough or their financial position warranted any expert advice.
The growth in exchanges at that time was being driven by the larger property owners and more sophisticated clients who had access to a team of professionals to help guide them and explain to them the benefits of exchanging.
When this report was revealed it became very clear that proper education of the public about the advantages that exchanging offers real estate investors, the market could probably grow by an additional 1 to 2% every year over the next decade.
The lack of knowledge that people have about exchanges should not be seen as a disadvantage. As a matter of fact, it is proof positive that the 1031 exchange market is ready to explode with growth, assuming that we educate people at a grass roots level. An aggressive marketer should consider this market share up for grabs and ready for the taking.
The growth rate of 1031 exchanges is very good and is projected to continue at what most people would consider an extremely healthy growth rate, allowing many opportunities for companies to expand and grow even with additional competition.
But above and beyond that, two types of replacement properties – Tenant in Common and Zero Cash Flow –offer even greater opportunities in conjunction with 1031s.In 2002, the Internal Revenue Service issued a revenue ruling setting forth a set of requirements that allow certain types of properties to be coowned with others and qualify as a likekind replacement property within a 1031 exchange.
These properties, known as Tenant in Common properties or TICs, allow many smaller individual investors to purchase institutional quality real estate such as grocerystore anchored shopping centers, large multifamily apartment complexes, and office parks and warehouses.
The market for Tenant in Common properties however is nothing short of phenomenal. Since the IRS has allowed Tenant in Common TIC properties to participate in an exchange, they have grown from 0 to over a $4,000,000,000 – that’s a four billion dollar industry in 4 short years. TICs are expected to continue this rocketing growth for the next 10 years and reach over $20,000,000,000 (twenty billion dollars) a year.
Because TICs are real property, they also qualify for an exchange when it comes time to liquidate and sell them. The TIC resale industry can even double their current total dollar amount in the future because they are still not known by many exchangers and are unheard of by almost all real estate agents, accountants, financial planners, and attorneys. The market growth of TICs as replacement properties in exchanges is mind boggling. Think how easy it would be to sell someone on this new form of real estate ownership by telling them, “Let me show you how to double or triple your real estate rental cash flow from what you now have and maybe even make it tax free”.
TICs usually offer cashoncash returns that are considerable higher – sometimes three times higher – than investors receive from smaller investment properties because of the way commercial properties are purchased with the concept of cash flow when large appreciation or speculation is not a top priority.
Another advantage of TIC properties is that they can come with debt. Not any debt, but nonrecourse debt, which means your client doesn’t even have to personally guarantee the loan. Your clients can now control possibly millions of dollars of top commercial real estate with minimum down payments and in some cases with nothing more than a credit score of 600 or more. The ability to leverage more property because of the mortgages that TICs offer can also give them the opportunity to generate massive amounts of depreciation, thus sheltering all the TIC rental income and making it all or virtually all tax free. Because of the quality of the properties that TICs offer, they usually have high rated companies as tenants, allowing for a more stable and predicable stream of rental income.
Finally TIC properties are usually located in the top growth areas of the US to allow for appreciation and have professional management in place so your client doesn’t even have to manage the property or make daytoday decisions. They just collect a check and forget they own it.
Zero cash flow properties on the other hand are a still small but growing market of approximately $300,000,000 per year. The reason they are small is that no one but a few experts in the world of exchanging, taxes, and commercial real estate truly understand them. As soon as a client and their accountants have the advantages of zero cash flow properties explained to them, they are sold!
The market for zero cash flow properties will begin to explode as more aging baby boomers start to retire and take advantage of these unique investments, beginning in 2011. Zero cash flow deals are extremely flexible and allow someone with as little as 15% down to purchase a property such as a singletenant CVS or Walgreen’s store. These properties are always prerented, have corporate guaranteed leases of 30 or more years, and come with special financing attached to them. The financing has a fast amortization, so that within 5 years of purchase your client may (if they want) refinance it for more money out than they initially put down to acquire it. The flexibility of the financing often allows investors to use the property as part of their retirement plan for themselves, or they could cash out today and then leave a future cash cow property to their children or grandchildren. After these types of property’s mortgages are paid off which usually occurs in 25 years, the properties can generate anywhere from $10,000 to $50,000 per month in net rental income. These properties also come with triple net leases and the tenants pay for all the maintenance and any increase in expenses. Most of the leases that come with these properties are also bondable meaning that even if the tenant stops paying the rent, the bond that is purchased to guarantee the loan from an insurance company will step in and pay the rent and all expenses. The flexibility and power that these properties offer especially when coupled with an exchange can leave even the most demanding investor wanting to learn more.
There are still many real estate and financial service professionals who do not fully understand the benefits of exchanges and do not even mention it to them as a viable option. Mentioning it to their client will only raise questions, and not wanting to appear ignorant, they take the path of least resistance and just say nothing.
It’s also possible that the client was advised about an exchange but given erroneous information. Many times we have heard that a seller was told by their accountant, attorney, financial advisor, or even a friend that they could do an exchange. The problem however was that the client was given wrong information. For example, many people including professionals, think that the concept of like kind means if you sell a 2family duplex you have to buy another 2family duplex as the replacement property. Many people have told us that they are surprised when we tell them that they can buy a future retirement home or even a home for their children through an exchange when their advisor said that it was impossible. The amount of misinformation given out by professionals today can easily explain their relative unpopularity.
What about the real estate agents who list a house for sale – why don’t they tell their clients about a 1031 exchange? After all, shouldn’t they be one of the first to recognize a candidate for an exchange? That’s true, but real estate is one of the most competitive industries around, and agents work very hard for every dollar they earn in commissions. After investing hours and days to sell the house, the last thing they want to do is throw a monkey wrench into the deal by confusing the seller with this information and causing him to possibly postpone selling (or even not selling at all). I am not going to judge if this is morally right or wrong, but it is how the industry sometimes works. There is something else that needs to be said in defense of real estate agents. Today, many people are trying to sell their house on their own to avoid or reduce the commission on their property. We noticed that a full 28% of our clients who execute a 1031 exchange sell their property without a real estate agent, or they use an MLS listing service only. The more people who do this, the less chance for a real estate agent to advise them about exchanges.
As a side note, we have seen many companies spring up overnight that offer forsaleby owner (FSBO) services. We decided to call one of the largest of these companies that services the New England market and ask them what type of advice they gave the people who listed their property for sale. They offered basic information about making sure the house was clean and ideas to stage it and needing smoke and fire alarms etc. No mention of 1031 exchanges anywhere. We called back and asked them if they knew what a 1031 exchange was and they said no. We then asked them how many pieces of real estate have been listed that could be considered investment property. They said that there were currently over 2,000 pieces of property listed and marked as investment property in their database. I wonder how many of those sellers are going to do an exchange?
The irony of the exchange industry is that people assume that it’s a very difficult industry to enter and get a foothold into, and that it requires years of special training and has difficult licensing requirements.
First of all it doesn’t require any of these things! After a few years in business performing exchanges you eventually develop a loyal following of clients who trust you and use you over and over again. Remember we said that many clients perform an exchange every three years? Eventually you will have enough repeat business, and then you can grow just with referrals. Many of the smaller firms want to stay small and some have decided to branch into additional profit centers while adhering to the statement of less is more and service your clients to death.
Many people claim to know about exchanges, and in all probability they do know some information. But most people really know only about the mechanics of an exchange and some of the basic advantages that they can offer an exchanger. They lack the depth of knowledge and understanding to explain many of the complex strategies that involve tenant in common interest, zero cash flow properties, and cost segregation analysis, which offer the biggest advantages