1.Make decisions based on concrete numbers. Capital gains tax and the motivation to defer those taxes using a 1031 exchange is a complex decision that should be made with as much information as possible. A taxpayer should consider their entire tax scenario, not just the property they are selling, before making a decision to exchange. There may be losses in other business lines to offset the gain on sale and this could decrease the motivation to exchange. Depreciation recapture is often not considered as a tax on sale and could be a motivation to utilize a 1031. Speak to your accountant, compile your true tax situation, and then make decisions based on those numbers.

2.Trust your trusted advisors. There is misinformation about 1031 Exchanges and it is important to know and trust sources of information when researching and planning the transaction. Much of the industry is based on interpretation of tax code from court cases and private letter rulings and requires background knowledge to make educated decisions. Knowing the experience level of your qualified intermediary and your tax advisors can help avoid tax pitfalls. The taxpayer is responsible for the accuracy of their exchange in an audit, not the person offering the advice.

3. Plan ahead. The 45 day deadline in particular makes many investors feel rushed to find suitable replacement property within the strict time frame. This pressure can result in the purchase of less than ideal replacement property or in a failed exchange with taxes due to the IRS. One way of avoiding this scenario is searching for replacement property and backup properties prior to the close of the sales property. Even if the exchangor plans on buying a single replacement property it is suggested to locate and identify a suitable alternative as early as possible. Working with a Tenant In Common or TIC dealer can provide numerous options for cash flowing, management free, real estate investments to identify within the 45 day timeline.

4.Make sure the left hand knows what the right hand is doing. A typical real estate transaction involves multiple parties including realtors, attorneys, accountants, and closing agents. In an exchange the intermediary is also in the loop and it is very important that there is open communication during the process. Delays are common when information is not available to everyone involved and an easy solution is the sharing of contact information during the planning phases. It is also important to alert the buyers of the exchange property and the seller of the replacement property by putting a 1031 addendum in both your sale and purchase contracts agreements.

5.Read and understand your exchange agreement. This document is the backbone of a 1031 Exchange and the composition can vary drastically among qualified intermediaries. There are no regulations on processing 1031 Exchange documentation, so each company must compile their own exchange agreement which leads to a wide variation industry wide. Before signing the exchange agreement at closing, be certain to understand the taxpayer rights and limitations during the exchange period and after. There are several safe harbors outlined in section 1031 of the IRS code and they should be addressed in the exchange agreement to assure a secure exchange.

What do subprime lending, supply and demand, foreclosures, echo boomers, empty nesters, escalated building costs, unaffordable housing, job growth, resort style amenities, immigration and growth markets have in common? They are all factors driving the increased demand for Class A apartment buildings across the United States.

With interest rates at record lows in conjunction with the tech bust of the early 2000’s, many investors were convinced to pull their assets from the stock market and funnel these dollars into real estate investments, specifically the U.S. housing market. This trend, combined with lenders willing to loan money to the most risky of borrows (subprime), led to a decreased demand for rental apartments across the country as many of the markets elite renters were now able to own a home rather than rent a unit.

Naturally, this real estate frenzy brought in the latest speculators and condo converters seeking to make a quick buck. The problem though is that many markets, like South Florida for example, were and remain artificially inflated with speculators and subprime loans. As the demand for home building and purchasing decreases, many speculators are now stuck with illiquid investments that they are either forced to carry or foreclose on. Adding fuel to the fire, many subprime mortgages are re-setting after their teaser 1% introductory periods expire, leaving many first-time owners compelled to rent.

These negative circumstances consisting of foreclosures, the elimination of subprime borrowers, and the vast supply of multi-family units that the condo converters removed from the market place, shared with recent and future demographic trends have created the “perfect storm” for rental apartment buildings. Many are well aware that over the next 20 years, 78 million baby boomers will be entering into retirement. Many of these boomers will become empty-nesters possibly seeking to downsize their need for larger family housing allowing them to potentially direct their primary resources towards other activities. The children of these boomers, known as the “echo boomers”, have a population size nearly that of their parents, about 76 million people. Born between1982 and 1994, the echo boomers are just beginning to graduate from college and enter the work force. This demographic segment may be the number one driving factor for rental living over the next 12 years as these boomers are currently seeking jobs, geographic relocation, and moving away from home. It may be difficult in today’s environment for these 21 year old young adults to afford a hefty down payment in order to purchase a single family home.

Affordable housing for both the baby and echo boomers, which is currently over 50% of the U.S. population, is expected to significantly boost the demand for rental apartment buildings over the next 12 to 20 years. Landlords are now able to push rents in many markets, resulting in rapid capital appreciation of apartments. In fact a Harvard University study issued in June 2007 stated that “The long-term outlook for residential investment remains strong.” As it relates directly to apartments, the report mentions, “The children of the baby boomers coming of age in the next decade [echo boomers] will reinforce the demand for rental units.” The Harvard study concludes that, “In fast-growing areas, the existing housing stock will be unable to accommodate the rising number of young households.”

It is important to understand the inverse relationship between rental real estate and direct real estate ownership. When it is an ideal time to purchase a home, the demand for rentals is driven downward. By the same token, when the demand for home purchases is down (today’s environment), usually rental growth is on the rise. 1031 Alternatives Group, through our real estate sponsor firms, has established an investment philosophy that emphasizes the aforementioned demographic trends, in this case as it specifically relates to apartment investments. For further information on these programs, please contact our offices directly for a complimentary brochure on “Demographic Investing”.