Free Spreadsheet to Learn Why Your Clients Should Consider a Tax-Deferred Exchange

Do you want an easy way to learn why you and your clients should consider a Section 1031 tax-deferred exchange? Over the past few weeks, I have been fine-tuning a couple of Buy and Hold vs. Buy and Exchange Spreadsheets. I think they are finally ready for prime-time, so I want to make them available to you, my Active Rain friends. These spreadsheets compare the idea of buying property and holding it to buying the same property but using a Section 1031 tax-deferred exchange after five years to releverage the investment into more valuable property.

I think the value of these spreadsheets will be realized in two ways. First, it will help you personally understand the incredible power of Section 1031 tax-deferred exchanges. And second, it will serve as a listing tool for you when you are discussing the possibility of selling an investment property or piece of land with a prospective seller. If you can show that seller how to increase his wealth by selling today, might that put you a step ahead of the guy down the street who’s just bugging him to list his property?

I’ll spend a few minutes describing the spreadsheets below. Let me disclose two things upfront: 1) there is no charge for these spreadsheets, of course, but 2) you have to put up with my logo and contact information on them if you want them. So assuming that you don’t mind a guy doing a little advertising with a free handout, let’s delve into them…

I mentioned there are two different spreadsheets. The first is for a standard property investment such as an apartment building or single-family home. The second one is specifically set up for land investments and deals in price per acre, not overall price. Please specify which spreadsheet (or both) you would like in your request! And be sure that I have your email address to send it to you!!!

The spreadsheets are based on the idea of comparing two different scenarios: 1) Buy a property and hold it for ten years, and 2) Buy that same property but exchange out of it after five years and see what happens in another five years. The comparison of gross equity after ten years is what we’re attempting to compare in these spreadsheets. The calculations are based upon assumptions that you make. One last comment before we get into this—when you get the spreadsheet, I promise it will be easier to understand than by reading all of this run-through below, but I felt like it was necessary to give you some idea of what was being offered.

Here is a screenshot of the assumptions required: (each one of these assumptions is made by the user; the ones shown are simply the last ones I made):

The entries in the yellow-shaded area are the assumptions you will need to make to generate a comparison. (The assumptions shown are simply the last ones I made.) Let’s discuss them one at a time

• Rate of appreciation—Enter the rate you expect the particular type of property you are working with to appreciate over the next ten years. This number can be negative, but it will remain constant throughout the ten years
• Interest rate on debt—What rate of interest will be paid on the debt over the next ten years. (This rate will remain constant over the ten years.)
• Number of payments—Over how many months will your loans be amortized?
• Purchase price—How much will you pay for this investment
• Fair market value—How much is the property actually worth today? If you are buying under the market value, your investment stands a much better chance of success. The old saying applies, “You make your money when you buy,” although I prefer, “You make your money when you buy and then buy again down the road through an exchange.”
• Amount of down payment—Enter your down payment, if any. You can enter zero if you are getting in with no down payment.
• Percentage of sale price paid in closing costs—Now we move on to the second five years on the exchange side of the equation. What is being asked here is for you to determine what percentage of your sale price is going to go to sales costs. If you expect to sell the property and pay a real estate commission, the commission itself will be 5-7% of the sales price. Based on your experience, what will the other costs add to that percentage? In my area, 10% is a reasonable estimate. Use what you think makes sense.
• Equity used as ______% down payment—When you sell after five years, we expect that you will have some money as a result of so doing. With that money, you are going to theoretically purchase a new, more valuable property (or properties). What percentage of the purchase price of the new property will your equity represent? In other words, if you will use your proceeds as a 25% down payment on the new property, enter “25.” The assumption on the screen is for a 20% down payment.

Now that the assumptions have been made and entered in the shaded area, let’s look at the comparison. The screenshot below shows the results on the Buy and Hold side based on the assumptions made above.

You can see that after ten years, the initial investment of $42,000 turned into Gross Equity of $184,170. Not bad! Let’s look at the Buy and Exchange side now:

Because I can’t get all of the Buy and Exchange side on my screen at once, you’ll have to trust me that the first four years of this side are identical to the Buy and Hold side. The fifth year is part of screenshot and you can verify for yourself that it is the same as the Buy & Hold side. What happens after the fifth year on the Buy & Exchange side is interesting, though. You can see that the Gross Equity after five years is $125,110. From that, $25,535 is deducted for costs of the sale of this property (based on the 10% assumption made), leaving $99,575 to reinvest into new property. At this point, it must be pointed out that if the investor did not use a Section 1031 exchange to reinvest into new property, a sizable portion of the $99,575 would go to capital gain taxes! Exchanging allows the investor to defer ALL of those taxes. Now, based upon the assumption that the proceeds of the sale were going to represent a 20% down payment on new property, the investor purchases a $497,873 property. This investor hasn’t gotten any dumber over the past five years, so he purchases the new property at the same proportion of Purchase Price to Fair Market Value as the first one was purchased. This means that the property he purchased for $497,873 has a Fair Market Value of $594,682. Remember, this is all based on the assumptions you make at the outset; if you don’t believe you can do as well, set the Purchase Price closer to Fair Market Value. The assumptions I’ve given you here are based on a real world deal that I am presently involved in, so it can be done! You can see that after ten years, the Buy & Exchange side realizes Gross Equity of $330,386, far in excess of the Buy & Hold side’s $184,170. This illustrates the POWER OF SECTION 1031 TAX-DEFERRED EXCHANGES!

One of the interesting things I have found by playing around with this spreadsheet is that you do not need to have all of the factors lined up in a positive way for exchanging to result in a better outcome. Try changing the Rate of Appreciation to -1.0% (negative 1.0%). The outcome is still better if you exchange after five years. (I hope you don’t expect your market to go down every year for the next ten years, by the way.) You can play around with the numbers and find scenarios where exchanging after five years doesn’t come out on top, but you have to invent some weird circumstances.

In closing, if you would like a copy of either or both of the spreadsheets, please remember to provide your email address and indicate which of the spreadsheets you would like to receive (one or both). I hope you enjoy working with them and that they result in greater equity for all!!

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

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Copyright © 2008 By Ken Tharp, All Rights Reserved. * Free Spreadsheet to Learn Why Your Clients Should Consider a Tax-Deferred Exchange * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.