Monthly Archives: August 2013

Illustrating the Savings from a 1031 Exchange

Illustrating the Savings from a 1031 Exchange
Follow the rules, and significant tax deferral could be yours.

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Real estate investors who want to defer capital gains have a neat option: they can take advantage of Internal Revenue Code Section 1031 to exchange out of one investment or business property for a “like-kind” property or equal or greater value. Usually, no gain or loss is recognized when you do a 1031 exchange.1,2

The one big demerit of a 1031 exchange is that you don’t have quick access to the sale proceeds – they go into an escrow fund maintained by a qualified intermediary. That has to happen, for if you take control of the proceeds, you have a sale, not a like-kind exchange.3

The advantages, however, are numerous. The definition of “like-kind” property is quite broad – the IRS website states that properties are like-kind so long as they “are of the same nature or character, even if they differ in grade or quality.” Additionally, it states that “real properties generally are of like-kind, regardless of whether the properties are improved or unimproved.” So an apartment complex might be exchanged for acreage, a strip shopping center for a horse ranch. A vacation home qualifies for a 1031 exchange if you live there less than 14 days a year or less than 10% of the time it is rented, or if you use it in some kind of trade or business venture.1,2,3

In addition, you get 180 days to close on a new property upon the sale of the old one, including a 45-day window to identify a “like-kind” property.2,3

Just how much money might you save in a like-kind exchange? Here’s a simple, hypothetical example. A real estate investor buys a duplex for $200,000. Five years later, she decides to get out of that property and replace it, but she doesn’t want to rack up capital gains taxes and taxes on depreciation. So she puts the duplex on the market for $300,000, gets that price, and hunts for a replacement property using a like-kind exchange.

If this were a typical real property sale, she would be looking at $100,000 in capital gains on the duplex and $36,365 in depreciation claimed (using the IRS formula in Publication 527, whereby residential investment properties can be depreciated over a 27.5 year time period, i.e., $7,273 x 5 = $36,365). Her ensuing tax liability would come to $136,365.4,5

Rather than be burdened with that kind of tax liability, our investor goes the 1031 route. She identifies a replacement property within 45 days, and closes escrow within 180 days. By accomplishing this, she successfully defers taxes on the entire $136,365 and she is able to direct those proceeds toward buying the replacement property.4

A 1031 exchange using a qualified intermediary can result in significant tax deferral and represent a convenient step for the savvy real property investor.

Citations. GREG OLIVER 90234934
1 –—Real-Estate-Tax-Tips [3/7/13]
2 – [4/08]
3 – [1/26/10]
4 – [4/23/13]
5 – [2012]

Understanding the Markets

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What the acronyms signify & what affects investors.


Dow. NASDAQ. S&P 500. Fear index. NYSE. Commodity prices. Earnings. Economic indicators. These are the gauges and signposts of investing, but if you stopped most people on the street, you’ll find they have only a hazy understanding of what these terms signify or reference. If you’ve ever been left dizzy by the jargon of the financial world, here is a brief article that may help clarify some of the arcana. Let’s start on Wall Street.

The major U.S. indices. The Dow Jones Industrial Average tracks how 30 publicly owned companies trade on a market day – the “blue chips”, 30 titans of U.S. and global business chosen by the Wall Street Journal, most not actually industrial. The NASDAQ Composite records the performance of 3,000+ companies on the NASDAQ Stock Market (see below), including many technology firms. The S&P 500 logs the performance of 500 leading publicly traded companies across ten different sectors (business/industry categories), as determined by financial research giant Standard & Poor’s (there was actually a Mr. Poor, hence the name).1,2

At the end of the trading day, these indices settle or “close” at a price level. The Dow is a price-weighted index – that is, its value each trading day rides up or down on the price movements of its 30 components. By contrast, the S&P 500 and NASDAQ (and most other stock indices) are cap-weighted, meaning the index value reflects the total market value of the companies in the index and not simply the prices of individual components. The S&P 500 has both a price return and a total return (the total return includes dividends).1,2

While the nightly news tells everyone what the Dow did today, many seasoned investors pay more attention to the S&P 500, which represents about 70% of the value of the U.S. stock market. There are other indices that also grab Wall Street’s attention. Investors watch the Russell 2000 (which lists the “small caps”, usually newer and younger firms than found in the predominantly “large-cap” S&P 500) and the Wilshire 5000, which tracks stocks of almost every publicly owned company in America (6,000+ components). Eyes are also on the “fear index”, the CBOE VIX (Chicago Board Options Exchange Volatility Index), which measures investors’ expectations of volatility (read: market risk) in the S&P 500 for the next 30 days. Important multinational indices (the MSCI World and Emerging Markets indices, the Global Dow, the S&P Global 100, and many more) and foreign indices (Japan’s Nikkei 225, Germany’s DAX, China’s Shanghai Composite and many others) also get a look.2,3,4,5

The stock exchanges. Stocks trade on exchanges, with the most prominent in America being the New York Stock Exchange (NYSE), the “big board” at which celebrities are seen ringing the opening or closing bell. Other notable U.S. stock and securities markets include the American Stock Exchange (AMEX), the CBOE and the NASDAQ Stock Market. While the NYSE trading day runs from 9:30am-4:00pm EST, pre-market and after-hours trading also occurs as investors respond to earnings announced after or before the bell or overseas developments.

The NYMEX, the COMEX & the forex market. The CME Group of Chicago owns and operates the New York Mercantile Exchange (NYMEX), the biggest physical commodities exchange on the planet. The NYMEX tracks energy futures such as oil and natural gas and it also has a COMEX division for metals such as gold, silver and copper futures. (Platinum and palladium futures actually trade on the NYMEX instead of the COMEX.) Agricultural commodity futures and options are traded on the CME Group’s Chicago Mercantile Exchange. Over-the-counter currency trading occurs via the worldwide, decentralized forex (foreign exchange) market. Short-term movements in exchange rates do influence stocks. 6,7

The bond market. Further decentralized trading occurs here, conducted by institutional and individual investors, governments and traders buying, selling and issuing government, corporate and mortgage-linked securities (and other varieties). Bond prices fall when bond yields rise, and vice versa. Interest rate changes affect the bond market more than any other factor; credit rating adjustments and changes in the appetite for risk (i.e., a race to or retreat from stocks by investors) can also play roles.

What moves the markets up and down? Information – or more precisely, the way large institutional investors respond to it. Things really move when the equilibrium of the market is upset by either positive or negative breaking news – it could be a geopolitical development, a natural disaster, a central bank decision, a comment from a Federal Reserve official or the Treasury Secretary, it could be many things. It could be earnings reports – corporate earnings are sometimes called the “mother’s milk” of stocks, and when two or three big companies beat estimates, Wall Street may see big gains that day.

The markets also respond to an ongoing stream of economic news releases from the federal government and other organizations. Federal Reserve policy announcements (interest rate adjustments, the implementation or cessation of stimulus efforts) get the most attention, and the Labor Department’s monthly employment report finishes second. Other critical monthly releases include the Commerce Department’s consumer spending report, the Bureau of Labor Statistics Consumer Price Index measuring consumer inflation, and monthly reports on existing home sales (from the National Association of Realtors), new home sales (from the Census Bureau) and home values (via the S&P/Case-Shiller Home Price Index).

There are other key reports: the occasionally contradictory consumer confidence surveys from the University of Michigan and the Conference Board (the CB poll is more respected, as it surveys 5,000 people; the Michigan poll surveys only 500, but asks many more questions) and the Institute for Supply Management’s monthly purchasing manager indexes assessing the health of the manufacturing and non-manufacturing sectors of the economy (these are simply surveys of purchasing managers at businesses, minus hard data).8,9

Hopefully, this makes things a little less mysterious. It takes a while to get to know the financial world and its pulse, but that knowledge may reward you in tangible and intangible ways.

GREG OLIVER / 789264782634789236489`64p8924`p89274293

1 – [1/25/13]
2 – [6/6/13]
3 – [6/6/13]
4 – [6/6/13]
5 – [6/6/13]
6 – [6/6/13]
7 – [6/6/13]
8 – [5/29/12]
9 – [6/3/13]