1031 Exchange? Yes Please!

Do you know the worst part about making money in commercial real estate???

Having to share it with the government when you decide to sell your investment property

Did you know there was a way to put off paying taxes on the money you earn on investment properties? And notice that I said put off and not avoid...unfortunately taxes are as sure as death so maybe you won't be paying the taxes today but you will have to pay eventually. I'll try and explain the process so even the most inexperienced investor understands the basics.

Something you really need to know about if you are planning on investing in real estate and what I am referring to is a 1031 exchange. The name comes from the particular section of the Internal Revenue Code (section 1031). Basically it's a way for you to sell a property and defer paying capital gains taxes by purchasing another property and reinvesting all of your profit.

As far as the person selling the property and completing the 1031 exchange is concerned, the whole process is transparent. You will have to add a few extra lines to the P&S but that's about it...

Here is how it works. I will use as an example, Steve, an investor, who currently owns a 3 family investment property and wants to buy a larger 6 family property.

1. Steve first consults his accountant and his financial planner to figure out his tax situation and what kind of profit he is looking at with the sale of his 3 family. He bought the 3 family for $100,000 3 years ago and its now worth $300,000. He has a potential gain of $200,000. The 6 family he wants to buy is listed for $500,000.


2. He contacts a QI (Qualified Intermediary) to discuss the 1031 exchange procedure. The QI is the middle man in the 1031 exchange process and you must use a QI, you can't do this on your own so don't try it.


3. Steve finds a buyer for his 3 family and puts in an offer for the 6 family which is accepted. Naturally he used a Buyer's Agent to find the new property. Here is where the fun begins...hold on tight!!!


4. Steve sells his 3 family and the $200K profit he just made is immediately transferred to the QI to hold for safe keeping until Steve closes on the 6 family.


5. At the same time as Steve is selling his 3 family, he is also working on closing on the 6 family. The QI takes the $200K he is holding for Steve and gives it to the guy selling Steve the 6 family. Steve then closes on the 6 family and never even sees the $200K and therefore doesn't have to pay any taxes on it. It's a beautiful thing...

Now for those of you that have had experience with a 1031 exchange, you will notice that I left out some of the details but my point here is to explain the process in a way that a novice investor can understand it. There are a couple of good references at the bottom of the post if you would like to learn more about 1031 exchanges. Here are some important points to consider when deciding to do a 1031 exchange...

1. The property you are buying must be of equal or greater value as the property you are selling.


2. In order to defer all capital gains taxes, you must reinvest all of your profits from the property you are selling into the property you are buying.


3. The IRS has a very strict timetable to complete a 1031 exchange. From the date that you sell your property you have 45 days to identify the property you wish to purchase and you must close on the new property within 180 days of the date that you sell the first property. The IRS doesn't care about weekends or holidays either...its calender days so if the 180th day is a Sunday and you waited until the last minute, you're out of luck since you can't record at the Registry of Deeds on a Sunday.


4. You are not avoiding the tax on the gain. In the example above, the gain was $200K but the money was reinvested in the new property. At some point, if Steve sells the 6 family, he has to pay taxes on the $200K profit he made on the sale of the 3 family unless he does another 1031 exchange and buys a property of even greater value.


5. You must hold the investment property for at least 2 years before the IRS will allow you to sell it and defer the payment of capital gains taxes.

Typically a QI will charge $1,500 to complete a 1031 exchange. I say typically because I only know about companies in my area and they all charge the same. Unfortunately there is no current regulations or licensing involved with being a QI so technically I guess they could charge whatever they want. If you are going down this road, make sure the company you are working with is reputable because as in my example above, the QI takes possession of $200K of Steve's money for a period of time while the exchange is completed. You have to be sure you can trust somebody holding $200K of your money.

Here are a couple of good resources to learn more about 1031 exchanges...

The Exchange Authority - This company is in Massachusetts but handles transactions all over the country and even overseas. I am working with a client completing a 1031 exchange now with this company. Tim Halligan is the man over there...

1031 Exchange, Wikipedia

What's a Vanilla Box Anyways?

I was reading Tina Devore's blog on Active Rain recently. She posted a requirement she had for some office space in the Lafayette Indiana area back in May. She described the requirement as being about 1,000 SF and the tenant would prefer a vanilla box.

One of the comments was somebody that asked simply, "What's a vanilla box anyways?"

I know what Tina meant and most commercial real estate professionals would know what she meant but obviously not everyone knew what she meant. So what does she mean when she says the tenant prefers a vanilla box?

Simply stated, when you are considering leasing office space in Leominster, or anywhere else for that matter, a vanilla box is an office that has not been painted or had any flooring put down or anything else done to it. I'm not sure exactly where the term comes from except that vanilla is a pretty plain flavor of ice cream and a vanilla box office is pretty plain looking since it hasn't been painted and it's like a box since all you see are the four walls with nothing built out within the walls. I searched Wikipedia for the term Vanilla Box and nothing comes up.

When a business owner is negotiating a lease for space in an office building or any commercial building, it's important to know the state in which the space he is leasing is going to be delivered. If the landlord uses the term "vanilla box", it will be up to the tenant to pay for paint, flooring, any built-in cabinetry or counter tops, and anything else that is custom to the particular tenant's business.

Typically a vanilla box office will have sheet rock walls ready for paint, a drop ceiling or a finished sheet rock ceiling depending on the building, a concrete floor ready for the installation of carpet or some other type of flooring, a bathroom (again, no paint here either), and usually the lights and plugs are installed. Anything else will be done at the expense of the tenant. Sometimes the landlord will give the tenant an allowance for construction improvements with the cost of the improvements being added to the base rent.

Now it should go without saying but I'll say it anyways, if a business owner is considering leasing office space or purchasing commercial property, the first thing that he should do is contact a commercial real estate professional to represent his interests. There are many other issues that come up in a real estate negotiation and there are many other real estate terms you need to know before you start lease negotiations and having professional representation by a buyer's agent will ensure the business owners questions are answered and he gets the best deal possible.

Are you interested in finding out more about leasing office space in Leominster? Check out these other posts...

Leominster Commercial Real Estate - Office Space For Lease Part 1

Leominster Commercial Real Estate - Office Space For Lease Part 2

Leominster Commercial Real Estate - Office Space For Lease Part 3

5 Reasons "Not" to hire a Buyer's Agent

Commercial real estate bloggers have been speaking on the hot topic of exclusive buyer's agents in commercial real estate lately. Below are a couple of recent posts

Benefiting from Tenant Representation at The Future of Commercial Real Estate

Buyer's Agents in Commercial Real Estate (Here at The Real Estate TrendMill)


What about the other side of the argument???


Maybe there's an argument for not engaging a real estate professional to represent you in your next commercial real estate negotiation. Maybe you should just do it yourself.


Below are what I think are the top 5 reasons a business owner/manager would NOT want to engage an exclusive buyer's agent and just represent themselves...in no particular order...

1. I'm an excellent negotiator. A business owner could do just fine negotiating with a property owner or listing agent for a commercial property. The owner of a plastics company that specializes in injection molding negotiates the price of resins all the time. What's the difference if you're buying resins or real estate???
2. I'm going to get a better deal if the listing agent doesn't have to pay a co-broke. If a business owner just contacts the listing agent directly rather than working with a buyer's agent then chances are the listing agent is going to go to bat for the business owner even though he has a fiduciary relationship with the property owner since he will be able to keep the full commission.
3. I have time to spare. A business owner can just spend 2 hours per day calling on classified ads and searching Internet listings for a new building and maybe an hour or two at the end of the week driving around the city looking at different properties. The company is growing like crazy thus the need for more space and the business pretty much runs itself so how busy could the business owner/manager be???
4. I have an attorney for things like this. A business owner can just pay his attorney to go over the paperwork provided by the listing agent and review any purchase documents. For $200/hour it's a great deal rather than risking having to overpay for a property since the owner has to pay the buyer's agent his commission along with the listing agent's commission. The business owner can just pay his attorney a little extra and have him research some comps to make sure the price is right.
5. I'm limiting myself by working with just one agent exclusively. A business owner would actually make out better by calling several real estate agents in the area to let them know that he is looking for a property. Now they are all out there working for him. If he works with just one exclusive agent, how will the other agents in the area know he is in the market for real estate???

Clearly you can see that in fact there are several reasons a business owner/manager would not want to work exclusively with one buyer's agent.

**That's satire with an "S"**