1031 Exchange vs. Cash Refinancing: Which Is Best For You?

by Prince Licaylicay | Jan 7, 2022 | 1031 Exchange, All Articles, Buying, Investing, Selling

If you’re like most real estate investors, you’re continually assessing your portfolio to see if you are spending your money well. That involves exploring your real estate choices to determine if you can extract your value and reinvest in a more successful investment vehicle.

You may realize this equity in your assets in one of two ways: selling the property or refinancing with cash out. But which is better for you: Selling your property and performing a 1031 exchange or refinancing the project and pulling your money out?

What is 1031 Exchange?

A 1031 Exchange, otherwise known as a like-kind exchange, is a swap of one investment property for another.  Kind transactions allow real estate professionals to grow and diversify their portfolios, with limited federal income tax implications. To qualify under Section 1031, there must be an exchange of real property held for the productive use in a trade or business or for investment solely for property of a like-kind to be held either for practical use in a trade or business or investment. It is a mode of asset appreciation on the exchange wherein the payment of tax is not eliminated but merely deferred until a later point when the taxpayer eventually sells the property received in the exchange.

What is Cash Refinancing?

A cash-out refinancing refers to a mortgage financing option where an old mortgage is replaced for a new one with a more significant amount than owed on an initial load, thus helping borrowers use the difference to procure some cash. In real estate, financing generally refers to replacing an existing mortgage for a new one that typically extends more favorable terms to the borrower. By refinancing a mortgage with a new one, you may be able to have potential access to cash, decrease the monthly mortgage payments, negotiate a lower interest rate, renegotiate the periodic loan terms, remove or add borrowers from the loan obligation.

Advantages of a 1031 Exchange

1. Low minimum investment and flexible investment amounts. Because multiple people are investing in the same asset, the minimal investment on a TIC property is usually lower than you might expect. In addition, since tenants own the property in a shared ownership agreement, each owner can maintain a different interest in the property. Moreover, the amount you can expect depends wholly on the size of your ownership, i.e., the larger the size of property owned, the larger the return and vice versa.
2. Higher potential for diversification and safety. Given that the safety barrier to the investment is lower in a TIC property, this fact offers many investors the chance to diversify their portfolios and invest in multiple properties. This, as a consequence, makes each investment secure since it lessens the likelihood of incurring significant losses.
3. Access to higher-quality real estate. Since people tend to pool their money for investment purposes, the TIC investor often has access to higher quality real estate than they would afford if they invest in the same using their own money. This also opens up an opportunity to attract tenants with higher levels of income.
4. Greater ease of ownership. Since the property has multiple owners, it means that there will be various hands that would be able to take care of the day-to-day operations and the management of the investment property. So while you may be able to pull your weight investment-wise, the amount of work you are expected to do is less than the work you will do if you own the property on your own.

Disadvantages of a 1031 Exchange

1. Shared risk means shared rewards. It should be noted that sharing a portion of the risk for investment purposes also requires you to share any rewards from it as well. For example, the portion of any rental income you receive will only be a portion of the whole, which is smaller than what you would usually receive if you were the sole investor. The reason behind this is that whatever profit you might earn is shared with your co-investors.
2. Little potential for unilateral decision-making. Undoubtedly, having co-owners also takes away your right to make unilateral decisions regarding the property. In addition, the IRS Revenue Ruling 2002-22 provides that a vote must take place before any major decisions may be made. Therefore, if you are not the type of person who does well in group decision-making, this type of investment may not be for you.

Advantages of Cash-out Refinance

1. Lower interest rates. A mortgage refinances usually offers a lower interest rate than a home equity line credit/home equity loan. A cash-out might give you a lower interest rate down the line, especially if you would have bought your property when mortgage rates were much higher.
2. Debt consolidation. Utilizing the money from a cash-out refinance to pay off interest-bearing loans that give high interest could save you thousands of dollars of interest. This is because Cash-out refinancing typically offers lower interest rates than you would have paid if you bought the property.
3. Higher credit score. Paying off your credit card in full due to a cash-out refinance will eventually build a positive credit score from the banks where you procured the loan. This reduces the credit rationalization ratio, i.e., that ratio the banks use to determine whether to lend you money or not, as well as the amount of credit available for you to use. Therefore, the higher the credit rating, the more money the banks are willing to lend you.
4. Tax deductions. Mortgage interests may be utilized as a deduction to the total amount of tax you will pay. In addition, this interest may be available on a cash-out refinance if the money will be used for the purchase, building, or the substantial improvement of your home. All of these interest expenses may be deducted from the total amount of tax due, which will benefit the taxpayer.

Disadvantages of Cash-out Refinance

1. Foreclosure risk. There is a foreclosure risk because your home is used as collateral for the mortgage. There is, therefore, a risk of losing your home if you cannot make prompt payments. Therefore, if you are doing a cash-out refinancing, always make sure that you are promptly paying your credit-card debt; otherwise, you run the risk of the possibility of losing your home because of the non-payment of the debt in due time.
2. Closing costs. The new mortgage will have different terms from the original loan. So, always make sure that the interest rates and fees are double-checked before agreeing to further terms and conditions. Otherwise, you will be exposed to risk because of ambiguous, extravagant closing costs that you could not take note of before closing the agreement or agreeing to new terms.

Refinancing a 1031 Exchange Property: Before and After

The mechanics of refinancing in 1031 transactions before exchange are relatively simple. The taxpayer pulls cash out of the relinquished property from a lender. This lender uses the equity in the property as collateral. Then, the taxpayer sells the property, pays off the loan, and then reacquires the debt on the purchase side of the exchange. The debt must be reacquired; otherwise, the taxpayer will have to pay tax on the cancellation of the debt. If the aforementioned process goes down without a hitch, the financial advantage is this: The taxpayer has pulled cash from his equity without triggering any tax liability. This will be even more advantageous if the new debt on the purchase has a lower interest rate than the refinance loan.

Furthermore, some tax experts feel that refinancing the replacement property after the exchange is preferable to refinancing the relinquished property before the exchange. In any case, you should think about the dangers and talk to your tax expert about your objectives.

CONCLUSION: If you want to sell your property and generate income with a low minimum investment and flexible investment amounts, or if you’re going to have a higher potential for diversification and safety, but shared risk means shared rewards, or if you’re going to have a limited ability to make unilateral decisions, then a 1031 exchange is for you. On the other hand, cash-out refinancing is the most fantastic option if you desire lower mortgage interest rates, the chance to combine your debt or a good credit rating.

Even after outlining all the information above, deciding whether to go for a 1031 Exchange or a Cash Refinancing can still seem daunting. That’s why the Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your business and investment goals. Contact us at (480) 330-8897 or send us an email at request@leveragedcre.com.

Need help on your 1031 Exchange? We got you covered! We prepared a free e-book that will serve as your guide to achieve your long-term business goals or obtain that property you’ve always been dreaming of!

Phill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns.

Bookmark www.leveragedcre.com to learn more about the Commercial Real Estate market and keep informed of relevant real estate strategies designed to maximize your income property investment results. Connect and follow Phill on Social Media at sm.leveragedcre.com/smplatform. #LeveragedCRE

1031 Exchange vs. Delaware Statutory Trust (DST)

by Prince Licaylicay | Nov 2, 2021 | 1031 Exchange, All Articles, Buying, Investing, Selling

The concepts on real estate investing can be tricky, especially if you don’t know the basics of each. Here, we have rounded up information about 1031 Exchanges vs. Delaware Statutory Trusts (DST).

Real estate investing has some advantages to boast, such as:

1. The use of leverage to increase returns;
2. Significant tax advantages from “non-cash” expenses such as depreciation;
3. The ability to defer capital gains taxes to the use of the 1031 like-kind exchange have long made real estate an attractive option for investors. 

What is a 1031 Exchange? 

1031 exchanges refer to the IRS code that provides the law and specific requirements regarding “like-kind” transactions. Like-kind transactions allow real estate professionals to grow and diversify their portfolios, with limited federal income tax implications. To qualify under Section 1031, there must be an exchange of real property held for the productive use in a trade, business or investment solely for property of a like-kind for practical use in a trade or business or investment. 

Investors have turned to 1031 exchanges to defer their capital gains taxes, as well as additional tax liabilities, which, in some states, include state capital gains taxes, Affordable Care Act surtaxes, and depreciation recapture taxes. 1031 Exchanges may permit real estate investors to perpetually defer these taxes provided that they continually reinvest capital back into other forms of real estate. In fact, the IRS allows subsequent exchanges each time a property is sold, which allows an investor’s equity to continue growth potentially. At the same time, be tax-free unless such investment is alienated, transferred, or sold.

What is a Delaware Statutory Trust (DST)?

 A Delaware Statutory Trust is a mode of real estate investment that provides individuals with an avenue to commercial investment properties that can be significantly larger than what they could acquire on their own. These properties are often the same type and quality as those purchased or owned by large institutional, corporate, or government investors, such as pension funds, insurance companies, or REITs.

DSTs provide 1031 exchange eligibility for individual investors upon entry and exit, a benefit not commonly available to other co-ownership structures. Moreover, DSTs can also provide tax-advantaged monthly income, which could be fully sheltered from income tax liabilities. Simply put, DSTs are professionally managed passive investments. They cover a wide range of property types, including, but not limited to the following: 

• Industrial Buildings;
• Multi-Family Apartment Complexes;
• Self-Storage Facilities;
• Medical Offices and other similar types of commercial estates. 

It is vital to note that Delaware Statutory Trusts are viewed as securities under Federal law and qualify as a like-kind exchange under Section 1031 of the IRS tax code.

Advantages of Delaware Statutory Trust (DST) 1031 Exchanges. Delaware Statutory Trust (DST) 1031 Exchanges offer many benefits to Investors. The following are its advantages:

• 1031 Exchange Eligible. DSTs are customarily viewed as securities under the federal securities laws. Hence, they are treated as direct real estate ownership under Section 1031 of the IRS tax code. Accordingly, the DST investments are eligible for 1031 exchanges both when it is initially invested and when it is liquidated.

• Institutional-Grade Assets. DSTs are compartmental or co-investment properties that allow numerous 1031 investors to acquire equity ownership interests in significant, high-quality assets that would typically be out of reach. By exchanging into a Delaware Statutory Trust and merging equity with other co-owners, 1031 investors can own a portion of an institutional-grade property that is significantly larger than what they could ordinarily purchase on their own. 

• Opportunities for Diversification. Since a person can choose the amount to be invested in a Delaware Statutory Trust, he can split his investment between and among multiple DST properties, thereby allowing the opportunity to diversify his real estate portfolio and, therefore, lessen the risk of a loss. 

• Earn normal distributions. Delaware Statutory Trusts are allowed to keep a reasonable amount of cash reserves to be prepared in case of a contingent event that would necessitate repairs or face unexpected expenses. However, all earnings and proceeds above the reserve amounts must be appropriated to the beneficiaries on a routine basis and within an expected period. 

• Sizing. One of the challenges for 1031 exchange investors is finding like-kind replacement properties that closely match the value of their alienated or transferred assets. If replacement properties are too small or too large in value, investors may be left with excess, and therefore, taxable funds. However, DSTs allow an investor to invest a definite and exact amount necessary to satisfy exchange requirements.

• Non-recourse Debt. Mortgage financing is already in place when a DST includes debt. The loan, however, is typically non-recourse, i.e., the investor’s assets outside the loan are protected.

Disadvantages of Delaware Statutory Trust 1031 Exchanges: 

• Lack of Control. With Delaware Statutory Trusts, investors can still enjoy the benefits of owning real estate without dealing with the day-to-day responsibilities of actively managing real estate. Although this may be a plus for some, others do not want to give up their management responsibilities. With a DST, investors do not have operational control or have the ability to make management decisions.

• Inability to raise new capital/refinance. Once the DST offering closes, there won’t be future contributions by current or new investors. Major expenditures such as changing or refurbishing a roof can consume several year’s profits. In the same vein, changes in occupancy or diminution in rents can destroy or lessen a property’s cash flow. This means property maintenance can eat up a large chunk of profit. Hence, it is essential to have reserves that are set aside in advance.

• Not liquid. DSTs have moderate to long-term hold periods, typically five to 10 years. And therefore, they are not liquid, i.e., quickly sold for cash. 

Conclusion. The 1031 exchange and the Delaware Statutory Trust are well known and highly effective tools for real estate investors to utilize. However, it should be noted that while the concepts of both are pretty straightforward, the details and execution can get a bit tricky. As such, investors utilizing the 1031 and DST options should consult with real estate investment and tax professionals.

While the information at hand can be overwhelming, there are many ways in which you can simplify your understanding of 1031 exchanges and DST’s. Choose the best commercial broker and company to help you understand the ins and outs of these concepts. 

Even after outlining all the information above, investing in CRE and the 1031 Exchange process can still seem daunting. That’s why the Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your investment goals. Contact us at (480) 330-8897 or send us an email at request@leveragedcre.com.

Need help on your 1031 Exchange? We got you covered! We prepared a free e-book that will serve as your guide to achieve your long-term business goals or obtain that property you’ve always been dreaming of!

Phill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns.

Bookmark www.leveragedcre.com to learn more about the Commercial Real Estate market and keep informed of relevant real estate strategies designed to maximize your income property investment results. Connect and follow Phill on Social Media at sm.leveragedcre.com/smplatform. #LeveragedCRE

Advanced 1031 Exchange Strategies

by Prince Licaylicay | Jul 8, 2021 | 1031 Exchange, All Articles, Buying, Investing, Selling

Most people are aware of the fact that when you sell a long-term investment, which includes real estate, you have to pay taxes. And generally, taxes don’t come cheap.

One of the strategies investors use is the 1031 Deferred Tax Exchange or simply, 1031 Exchange. Since we’ve talked about 1031 Exchange in our previous article, today we’re going to focus more on the Advanced 1031 Exchange Strategies and what you need to know.

Below are four (4) Advanced 1031 Exchange Strategies that investors commonly use:

Delayed Exchange

This is the most common and widely used by investors doing a 1031 Exchange. A Delayed Exchange happens when the exchanger sells their property (relinquished property) first and purchase a new property (replacement property) second by using the sale proceeds.

Usually, the investor hires a third party, known as the Qualified Intermediary (QI) to facilitate the process of the exchange. After selling the relinquished property, the Qualified Intermediary holds the sale proceeds in escrow, and under 1031 Exchange Rules, a replacement property must be identified within 45 days, purchase the replacement property and complete the exchange within 180 calendar days.

Reverse Exchange

While in most cases investors use the Delayed Exchange, there are certain situations where they are having difficulties locating a viable property to be acquired after selling the relinquished property. In cases like these, investors use the concept of Reverse Exchange.

Reverse Exchange is the opposite of Delayed Exchange. Utilizing this strategy allows the investor or exchanger to acquire the replacement property first before selling the relinquished property.  Acquisition of the parked property is the first step and afterward, the exchanger is given 45 days from the purchase date to identify the property that he/she plans to sell and 180 days from the date of purchase to complete the exchange.

Improvement or Construction Exchange

There are times that an exchanger might want to build their replacement property according to their own specifications. Construction Exchange is a perfect strategy for an exchanger to not only acquire the property but also improve it so that the value of the purchased price plus improvements get them to their target replacement. It can be either be a ground-up construction or a renovation. The exchanger, after selling the relinquished property and identifying the replacement property, is given a total of 180 days to finish the construction of the property and close the transaction to complete the exchange. 

Simultaneous Exchange

This is a type of exchange where the sale of the relinquished property and the purchase of the replacement property happen on the same day. It can either be (a) a two-party exchange where the owners of the relinquished property and replacement property trade or swap deeds, or (b) a three-party exchange where an “accommodating party” is present that acts as an intermediary to facilitate the exchange, or (c) a Qualified Intermediary – an expert in 1031 Exchanges, is involved to facilitate the whole process of the transaction and makes sure that the exchange follows all the guidelines under the Internal Revenue Service (IRS) Tax Code.

Even after outlining all the information above, investing in CRE can still seem daunting. That’s why the Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your investment goals. Contact us at (480) 330-8897 or send us an email at request@leveragedcre.com.

Need help on your 1031 Exchange? We got you covered! We prepared a free e-book that will serve as your guide to achieve your long-term business goals or obtain that property you’ve always been dreaming of!

Phill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns.

Bookmark www.leveragedcre.com to learn more about the Commercial Real Estate market and keep informed of relevant real estate strategies designed to maximize your income property investment results. Connect and follow Phill on Social Media at sm.leveragedcre.com/smplatform. #LeveragedCRE