The 1031 Advantage

Positioned on the front lines of the industry, agents hold a clear advantage when it comes to investing in real estate. Understanding and using tools such as Section 1031 of the tax code, agents not only can create effective investment strategies for themselves, but also can serve as trusted advisers when working with clients interested in doing the same.

It’s a win-win situation that many agents are capitalizing on to their personal and professional benefit. Still, other agents remain intrigued but hesitant to take the next step. Are you one of them?

As most CRSs know, Section 1031 tax-free exchanges apply to any property held for investment purposes, or for productive use in a trade or business, and is often referred to as a “tax-free” exchange. Instead of a straight buy/sell/buy, investors can “exchange” one property for another — essentially by passing or postponing paying taxes on the profit. Instead, that capital can be used to trade up in investments.

In general, an investor can use Section1031 provisions to defer most investment taxes if they use a Qualified Intermediary and identify up to three “like-kind” investment properties within45 days of the close of escrow of the sold property and complete the new purchase(s) within 180 days of closing.

In addition, the value of the replacement property must be equal to or greater than the value (the purchase price adjusted for actual closing costs) of the sold property. For example, a $150,000 property whose sale requires closing costs of $8,000 would be valued at $142,000.

Agents who know the ins and outs of how these transactions work instantly boost their credibility with the highly attractive investor client niche.

For agents, investing in single-family homes or multiunit residential properties makes sense, based on their experience in pricing, access to available properties, network of contractors and service providers, contract familiarity, and related finance and negotiating skills.

Such investments can also provide retirement benefits that are not always within reach for independent contractors, says Bill Graves, CRS, a sales associate with Prudential Fox and Roach in Newtown, Pa. In real estate since 1989, Graves has completed numerous 1031 Exchanges for clients, and he sees the option as a viable investment strategy for CRSs.

“As a REALTOR®, you possess negotiating skills and insider information about the market, and it’s why 1031 Exchanges can really work in your favor,” says Graves.

Joann W. Rodman, CRS, GRI, a broker-associate with Coldwell Banker Residential Real Estate’s Orlando South office, concurs, and her understanding of the tax law has helped make investors one of her primary market niches. Over the past 22 years, Rodman has helped clients work through countless 1031 Exchanges. One of her earliest encounters with 1031s involved a company that was moving from Hawaii to Florida and was interested in buying property in the Sunshine State.

Rodman says she “learned along the way” during those first few transactions and relied on the help of a qualified intermediary to handle the deal. Upon selling the property in Hawaii and reaping the tax benefits of the 1031 Exchange, the company moved to Florida to occupy its new property. Since then, the firm has done at least one other 1031 transaction. “We did it almost sight unseen,” says Rodman, “and it was as smooth as glass.”

There are obviously many nuances and details of 1031 Exchanges that are important to understand. The Council of Residential Specialists incorporates the information into its training courses, such as Creating Wealth through Residential Real Estate Investments (CRS 204), and other educational opportunities are available. Graves advises that agents learn as much as they can about the investment landscape (including apartments, duplexes and condominiums) in their regions to get a feel for what’s out there for investors who want to “exchange” their current properties via a 1031.

Last, Graves recommends connecting with one or more qualified intermediaries. Visit www.1031.org for starters. “Network with a company that handles these types of transactions, collect their brochures and information, and keep it handy for passing along to a potential buyer.”

In sum, being able to help clients through the 1031 process is yet another way agents can boost their value in the eyes of consumers. “When I’m representing buyers, I can talk to them about the advantages of using a 1031 versus a straight purchase,” Graves says. “Many times, they don’t even know about this option, and how it allows them to transfer equity without having to pay any capital gains tax.” And what better way to learn the ropes of real estate investing than by doing it yourself? Practice what you preach and you’ll benefit that much more.

Mike Merin, CRS, CRB, is an associate broker and industry teacher/consultant. He is the author of Attack the Market: Invest!

Doug Richards, CRS, CCIM, is a former CPA and a Senior Instructor for the Council of Residential Specialists. Richards teaches Creating Wealth through Residential Real Estate Investments (CRS 204).

The 1031 serves as an effective way to defer paying taxes that would otherwise have been due on the sale of a residential investment property. Keeping it simple, the investor who buys a property for $200,000, for example, and sells it in six years for$250,000 would typically have to pay capital gains tax on the $50,000 gain. If he or she invests in another “like-kind” property of equal or greater value, however, then those taxes are deferred until the property is sold outright. As long as the money continues to be reinvested in real estate, the capital gains taxes are deferred.