Take A Look At A 1031 Tax Free Exchange As A Commercial Pre-Foreclosure Strategy

By
Managing Real Estate Broker with The Reata Realty Group
Take A Look At A 1031 Tax Free Exchange As A Commercial Pre-Foreclosure Strategy

I browsed through this information last night inside the new Realtor magazine regarding using a 1031 Tax-free exchange in a real estate foreclosure deal as a way to defer the capital gains taxes owed on the lost asset. I had not considered this but this may save your clients plenty of money.

The
method is not new, it was used commonly back in the early 1990's throughout the last commercial real estate meltdown. Today in a  much the same market scenario, lots of individuals are turning to this strategy just as before.

When you find yourself attempting to decide if a zero-income property exchange suits your client, figure out how much capital gains the foreclosure will probably produce. The catch here is at least pertaining to tax purposes, no matter whether the value will be less than the financial debt. You could have a gain. If the property is financed and then foreclosed the debt is considered the actual sales price, plus the owners increase is actually equal to the excess on the financial debt above the tax basis. This is where it can be sticky,there are different guidelines with regard to recourse debt, creating the potential for a mix of capital gain or loss and ordinary income from the termination regarding financial debt whenever recourse debt is foreclosed.

So here is an alternative that can help some owners when a foreclosure creates a capital gain. By exchanging the pre-foreclosure property for a property of equivalent worth, the owner can defer the capital gain but still fulfill the bank obligation. In this particular type of  deal the owner will not recieve any money in the foreclosure process therefore he generally won't always have any money to purchase the exchanged property. That's where the zero interest substitute property comes in.

The zero interest property is one that is highly leveraged as well as leased on a triple net basis to a credit tenant. For example Barnes and Noble. Almost all revenue from the property goes to support financial debt and also the tenant pays all of the bills, so there is no positive or negative cash flow. Due to the higher leverage on the property there may be a small amount of equity needed to fulfill the exchange providing the mortgage will be assumed on the property from the buyer. Even though there isn't any boot paid they will have to bring about about 10 or 15%  to the table in order to complete the transaction for the exchange.

For the most part, the zero interest exchange works best for corporations, which tend not to receive  capital gains benefits, however it is worth examining for any of your clients.

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Happy Trails,

DK

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commercial property
tax free exchange
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Rainmaker
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P.J. Virgilio Jr., Realtor 408-568-6578 Selling homes in the Greater San Jose area and South through San Martin, Gilroy
Keller Williams Realty Silicon Valley - Gilroy, CA
San Juan Bautista and Hollister as well!

Donnie,

This is the second time in several months I heard about this strategy, still confusing to me but very interesting.

Nov 12, 2010 05:24 AM #1
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Donnie Keller

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