A 1031 EXCHANGE CAN ENRICH YOUR LIFE

Carlton Hartz never suspected his rental property in the Silverlake would allow him to upgrade to a new, larger property closer to the Westside – without paying a dime in capital gains taxes this year. Then again, they never imagined the Internal Revenue Service would help him pay for it, either.

Hartz bought this propeerty through a 1031 exchange - a little-used tax shelter for investment real estate owners. The term 1031 is the number of the Internal Revenue code that allows for the tax-deferred exchange of any type of business or investment property for similar property.

"This has been part of the tax code for 80 years and yet so many people still don't know about it," observed Margaret McDonnell, president of 1031 Corp. "And the worst part is that they're selling property, putting the money in the bank and buying a new property; so they're doing everything they need to do for a 1031 exchange, but they're not getting the benefit because they didn't structure it that way."

By taking advantage of the 1031 Exchange option, Hartz managed to sell his highly appreciated rental property on the Eastside and upgrade to a Westside property might someday become his retirement home - but in the meantime, it'll generate substantial income.

"The area where our old four-plex was located had became very popular and the value had really gone up. I was able to cash in without paying taxes, plus we got to keep that money in property," Hartz stated, noting that the use of a 1031 Exchange allowed him to defer "tens of thousands of dollars" in capital gains. "I would highly recommend this to anyone."

The 1031 exchanges allow individuals and corporations to trade in existing business and investment property for new property -- and defer the capital gains tax along the way. Traditionally, 1031 Exchanges were used most by owners of large commercial real estate properties, including shopping malls and golf courses. But they're starting to catch on among smaller investors as well, especially those who own vacation rental properties and undeveloped land.

"This is one of the last goodies in real estate," declared Kelly Yates, an attorney and house council to the Exchange Facilitator Corp. to www.money.com. "Our typical customer is the mom and pop who maybe inherited land many years ago and want to move unproductive land into income-producing property. We also see the phenomenon of people in their 40s and 50s looking ahead to retirement and looking to sell a property to buy a home in Florida that they can rent and maybe retire to someday."

Advocates of 1031 exchanges say the best part about them is that you're able to reinvest the money you would otherwise have spent in capital gains taxes. To qualify for the tax deferred status, the proceeds from your sale must go back into your replacement property, but those are pre-tax dollars you're putting to work for you.

According to Tim Egan, executive director of the Federation of Exchange Accommodators, like-kind exchanges have been going strong for the past decade, when the Treasury Department adopted new guidelines for executing a tax-deferred exchange.

"The feedback we are getting from our members is that the preponderance of business these days is coming from small, mom-and-pop investors. They are the ones who benefit from this the most," noted Egan.

Any serious 1031 exchange prospect begins the process with a visit to a qualified intermediary, a firm approved by the IRS to facilitate 1031 exchanges.

"I would have never done this without the help of an expert," Hartz confirmed. "I had to buy and sell our properties ourselves, but they told us every regulation and every rule."

A proper 1031 exchange will see that you don't pay taxes on the transaction until you sell the replacement property. By that time, most investors are well into their retirement years and fall into a lower tax bracket. If you have a smart team offering investment advice, you may be able to avoid paying taxes altogether. That's because the capital gains tax you owe on replacement properties are forgiven upon your death...meaning your heirs won't get hit for taxes either.

"This can be a great estate planning tool," observed Margo McDonnell, president of 1031 Corp., a qualified intermediary.

As with all investments, consult a tax professional to make sure this option is right for you.