Tax deferred exchanges -- the last great savings tool

Part 2 of a 2-part series

(see Part 1)

Last month we examined some common misconceptions about tax deferred exchanges. This month's concluding exchange article looks at some of the more important benefits derived from a well structured exchange.

Increased selling power

The exchanger has greater selling power by not having to inflate the sales price to try to cover some of the capital gains normally due upon the sale of an investment property. Additionally, because investors are traditionally property rich but cash poor, an exchange offered at a lower price can often increase the pool of buyers willing to consider acquiring the property.

Increased buying power

The exchanger builds more buying power simply because federal income taxes are deferred. Thus, an exchanger investor looking to acquire investment properties has a larger amount of money available to acquire replacement property(s). This is because the exchanger investor retains the dollars that would otherwise be paid in taxes to purchase other investment property(s).

Estate preservation

Many investors combine the tax deferral elements of exchanges with the estate basis rules to create a family tax shelter. The exchange investor can constantly exchange property, deferring his or her taxes, develop a growing positive cash flow, refinance to generate additional cash, and ultimately transfer the property with a basis equal to its value to his heirs.

Reduce management involvement

The on-going maintenance and management of a geographically dispersed, scattered group of properties can often be reduced by exchanging these properties for a single property with little or no direct management and requiring less maintenance.

Diversify a large property

One large property in a certain area can be exchanged for two or more smaller properties in different areas. Another diversification strategy is to acquire a different type of property such as exchanging from several residential units to a single small retail strip center.

Larger pool of investors

Motivated investors often already own property but they are generally property rich but cash poor. So when they offer their property for exchange, a greater population of buyers are available who are likewise also property rich and cash poor. Most of these are motivated acquirers who are ready, willing, and able exchangers willing to offer equity instead of their hard earned cash. Thus, eliminating or reducing the up-front cash outlay requirement can make a deal possible that would otherwise not work.

Estate conservation

Structuring an exchange eliminates the requirements of an outright sale without paying taxes that otherwise would be due if the property was sold outright instead of exchanged. Current equity is realized and taxes are deferred on a gain that otherwise would be due from the sale. This allows property owners to create and conserve an estate that passes greater wealth to their heirs and family.

The reasons for considering an exchange often vary greatly from person to person and their separate motivations and goals. Some owners want to reduce management concerns, others desire to acquire larger investments, others want to acquire specific types of investment properties, while others want to conserve and build their estate for their heirs and family.

But before seriously considering an exchange, get a qualified attorney and/or tax adviser to help you cut through the mumbo-jumbo, understand the basic requirements, and put the transaction in motion.

Robert E Bunn is an acquisition and management consultant in Cape Girardeau. (573-335-3351 or email at rbunn@igateway.net