As published in Scotsman Guide's Commercial Edition, January 2006.
Most real estate pros think of 1031 exchanges only one way -- as a method for delaying the capital-gains tax on the sale of an investment property by transferring the equity to a like property. In fact, there are two additional applications for 1031 exchanges that can provide tremendous benefit to you and your clients. They can be used as tax-free vehicles for adjusting or diversifying real estate portfolios and as estate-planning tools.
With today's high property values, low interest rates, low capitalization rates and great available terms, now is the time to talk to your clients about evaluating their financial goals, needs and options.
Using 1031 exchanges to diversify or adjust a portfolio can be beneficial for numerous reasons. If your clients are in one or more of the following situations, then you might be well-served to suggest that they make some changes:
Geographically clustered portfolio: We know what happened after Hurricane Katrina, not to mention the 1992 riots in Los Angeles and various U.S. earthquakes. If your clients' properties are clustered in one geographic area, there's a real risk that the entire portfolio could be wiped out with one regionwide disaster. Spreading properties out could be of great benefit.
One property type: Many real estate investors make the economically risky decision to put all of their money in one property type. Instead, they could use a 1031 exchange to sell some of the portfolio and diversify into other property types (such as retail, office, industrial, commercial, multifamily or mixed use). The result will be a portfolio that can absorb a variety of economic conditions or changes.
Changing area: Neighborhoods, cities and regions are not static. Your clients may own properties in areas that are not going in the direction originally anticipated. For example, clients might own apartment buildings in a declining neighborhood or industrial property in an area that is being rezoned. Suggest to them that they rebalance the portfolio with properties in regions that more closely fit their investment goals.
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