Some people call it a tax-deferred exchange because they figure the tax will be paid someday.  But many savvy investors never pay capital gain tax. They keep exchanging throughout their entire lives and when they die, the gains die with them . . . never taxed.
Let’s cover the basics…

In general, an exchange is accomplished by selling your property and buying another.  The process is much simpler than most people think.  It’s really just a sale and a buy, with a few curveballs tossed in for good measure.  

It might be the word "exchange" that confuses people.  Instead of "exchanging," the process should really be called "continuing."  If you merely continue your investment, the IRS says, "Okay, since you’re continuing your investment you don’t have to pay tax on your gain at this time."  Your gain is carried forward to the replacement property.  If you someday sell the replacement property, the gain would be taxed then.  But, instead of selling what could you do?  Exchange!  If you kept doing this your entire life, all the gains would be forgiven when you die because of the "stepped up basis rules."

As long as the only thing you receive in the exchange is "like-kind real property" you’re merely "continuing" your investment and your gain is not taxed.  "Like-kind real property" is any real property held for investment or use in a trade or business. 

If you receive any "unlike-kind property" part, or all, of your gain may be taxed.  The three types of "unlike property" are:
    1.  Cash.
    2.  Boot (defined as "any non-cash asset" i.e. a boat, a car).
    3.  Net loan relief (when you owe less after the exchange than you     did before the exchange).

Now, let’s talk about the mechanics of an exchange.  Since everyone’s situation is unique, be sure to get good legal and tax advice before you actually do an exchange.  Also, keep in mind that I’m going to simplify the process and show you one way to do an exchange. 

The first step is to put your property up for sale.  That’s right, for sale.  The reason is that the owner of the replacement property that you want probably doesn’t want your property … he or she wants your cash equity.  And how do you convert your equity into cash?  By selling your property.

Now you may be thinking, "If I sell my property I’ve got to pay tax on my gain."  But here’s the good part.  If you clearly demonstrate that your intent is to do an exchange, the rules allow you to sell your property.  But instead of receiving your equity proceeds (which would be "unlike property") at the closing, these proceeds are placed into a qualified escrow account.  You don’t receive the money and you don’t even have the right to withdraw or use the money from the escrow.  The beauty of this arrangement is that, yes, you’ve sold your property and converted your equity to cash but you haven’t received any unlike property.  This is called a delayed (or "Starker" exchange named after the guy who first did a delayed exchange).

To complete the delayed exchange you must meet two time tests:

1.  You have 45 days from the day you sold your old property and the money was placed in the qualified escrow to "identify" a replacement property. 

2.  You have 180 days to actually acquire the replacement property. 

Now, it’s not 45 days plus 180 days.  Both of the time periods begin on the day you sell the old property. 

Look at the power of this!  By doing a delayed exchange, you have sold your old property, placed the proceeds into a qualified escrow account, identified a replacement property (within 45 days) and purchased the replacement property (within 180 days).

It’s really just a sale and a buy, but it’s treated as an exchange.  And, as long as the only thing you receive is like-kind property,  you don’t have to pay any tax on your gain!  Fantastic!

Many title companies and escrow companies are geared up to be the qualified escrow holder.  If you’re searching for a company to act as your escrow holder, merely call them up and ask if they handle delayed exchanges.  If they answer something like, "Well, ahhh, most of our closings get delayed!" you’ve called the wrong company!

Once the dust has settled, you have sold your old property and purchased another.  But, if you do it right, you’re treated as if you did an exchange.  And, if the only thing you received is like-kind property, you’re merely "continuing" your investment, and you don’t have to pay tax on your gain!  What a country! 

©Copyright Tom Lundstedt Seminars
Reprinted with permission from the author

This material is designed to provide information about the subject matter covered.  The accuracy of the information is not guaranteed.  This material is sold or offered with the understanding that the author is not engaged in rendering legal, accounting or other professional services.  If legal advice or other expert assistance is required, the services of a competent professional should be sought.

Her retirement account, like many others, has suffered as a result of investment choices.  Norma went on to tell me she wished she had bought real estate instead of "investing in an IRA."  She was amazed when I told her she could have her cake and eat it too ––– or rather, have her IRA and real estate too!  Let me explain.

First and foremost:  A retirement account (traditional IRA, Roth IRA, SIMPLE IRA, SEP, Keogh, 401k, etc.) is not an investment!  It’s simply a special account that holds your investments.  It can hold many types of investments, such as mutual funds, stocks, bonds, and . . . drum roll, please:  investment real estate. 

Picture a truck with the words "MY RETIREMENT ACCOUNT" painted on the doors.  In the back of the truck, you load whichever allowable investments you choose.  As you picture this, ask yourself, " Is my retirement truck on the way to becoming a big, heavy-duty monster truck or will I end up with a little, wimpy mini pickup?"

When I told Norma her retirement account could own real estate she said, "But I asked the company that administers my account if my IRA could own real estate, and they said ‘no.’" 

Whoa!  Instead of merely saying "no," the person she talked with should have added three important words: "not with us." 

The problem is that most companies that hold retirement accounts aren’t geared up to handle real estate.  Therefore, they have no incentive to inform their customers that real estate is an alternative investment choice.  That’s the main reason for the misconception that real estate can’t be held in a retirement account.

Let’s get this straight:  retirement accounts can own real estate.

In a minute, we’ll get to the basic ins and outs of real estate IRAs.  But first some advice:  This article is designed to be a launching pad for readers to begin their exploration of real estate IRAs. It’s a complicated subject and everyone’s situation is unique, so be sure to talk with your competent advisors before you take any action.  OK, here we go.

First, establish a self-directed retirement account with a company/custodian that specializes in real estate IRAs.  (Use an internet search engine to find several companies that specialize in self-directed retirement accounts.)
This is a relatively easy process and can be done by either establishing a new account, or rolling over the assets of an existing account.  (Be sure there are no surrender charges for rolling over an existing account.)

Once you’re the proud owner of a self-directed IRA with a custodian that can handle real estate, what’s next?  There are specific rules as to what you can and cannot do with your real estate IRA.

Some Things You Can Do:

1.  Your real estate IRA can buy and sell many types of real estate including raw land, rental properties, condos, fixer-uppers, commercial properties, lakeshore, etc. 

Keep in mind it’s the self-directed real estate IRA that buys, owns and sells the property.  Not you personally.  You don’t withdraw the money from the IRA to buy the property – the custodian buys the property in the name of your self-directed real estate IRA.

2.  The property can be rented but the rental income is paid into your IRA, not to you.

3.  All the expenses of renting and operating the property must flow in and out of your self-directed real estate IRA.

Be sure your self-directed real estate IRA has enough liquid reserve funds to cover operating expenses, improvements, etc.

4.  It is possible to finance a property that is owned by your IRA.  But the financing must be "non-recourse."  That means the property, not the IRA account, is the sole security for the loan.  Most traditional lenders won’t provide non-recourse financing.  But several of the self-directed retirement account administrators can suggest lenders that specialize in making loans to retirement accounts.  In addition, seller financing or private loans are possibilities.  Let me emphasize again:  get good professional advice before taking any action.

5.  Your real estate IRA can buy a partial interest in a property.  This is useful if your IRA doesn’t have enough money to buy 100% of the property.  It could be a partner and own a fractional interest.

Some Things You Cannot Do:

1.  Your real estate IRA cannot buy a property that you, your spouse, or certain family members already own.  Likewise, your real estate IRA cannot sell a property it owns to you, your spouse or certain family members.

2.  You, your spouse or certain family members cannot have any personal use of the property owned by your real estate IRA.

3.  Your IRA cannot lease the property to your business.  Your business cannot use or occupy any part of the property.

Is a Real Estate IRA Right for You?

So, now you know you can use your retirement account to buy real estate.  But the bigger issue is should you use your retirement account to buy real estate?  The answer is, it depends on the type of real estate and your unique situation.

You already know your real estate IRA cannot own property that is used by you, certain family members or your business.  Therefore, primary residences, second homes and vacation homes are not candidates.

In addition, a rental property that produces tax shelter from depreciation deductions would probably not be a good fit because the tax shelter would go to waste in your retirement account. 

Other types of real estate, such as raw land, fixer-uppers, and non-leveraged rental properties, are perfect candidates.  The profit from these investments would be taxed if you owned the property personally.  However, if your real estate IRA buys, owns and sells the property, the profit would compound in your IRA tax-deferred (or tax-free if it’s a Roth IRA)! 

There is a limit on how much you can contribute each year to your retirement account.  But there’s no limit on how much the account can earn! 
Hubba hubba!

Last But Not Least

1.  Before your IRA buys any property, you’ve got to understand how real estate works.  There’s a lot to it.  Make a commitment to learn how to analyze a property before you buy it, including operating expenses and management considerations.  Study the financial benefits such as cash flow, depreciation and appreciation.  Learn how to determine cap rates, cash on cash and other rates of return.  And so on.  The more you know, the better your chance of success. 

2.  Remember that real estate IRAs are a specialty and not every retirement account administrator/custodian is geared up to handle them.  Be sure to deal with an experienced specialist.

3.  If you’re in the real estate profession, I hope you can see the huge potential of real estate IRAs.  Think of the millions of dollars that are sitting in the retirement accounts of your potential clients.  Get out there and help them take advantage of a great opportunity!

And finally, if the choices you’ve made so far for your retirement account aren’t taking you where you want to go, find a new vehicle.  Real estate opportunities are everywhere for those savvy enough to recognize them and motivated enough to take action.

Whatever Happened to Norma?

Sometimes I wonder if anyone ever acts on the information they receive in my seminars.  I can only hope.  But if I let my imagination run wild . . . It’s 20 years from now and I’m driving down the interstate when a huge, shining, beautiful 18-wheeler semi truck pulls along side me.  The driver gives a friendly toot on the air horn, waves and smiles.  I can’t believe my eyes ––– it’s a little old lady wearing bright red glasses and as the truck passes I see huge lettering running from front to back:  "NORMA’S REAL ESTATE IRA!"

What a country!

©Copyright Tom Lundstedt Seminars
Reprinted with permission from the author

This material is designed to provide information about the subject matter covered.  The accuracy of the information is not guaranteed.  This material is sold or offered with the understanding that the author is not engaged in rendering legal, accounting or other professional services.  If legal advice or other expert assistance is required, the services of a competent professional should be sought.

Tom Lundstedt "Use Your Retirement Account to Invest in Real Estate"

Let’s get this straight: retirement accounts can own real estate.

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If you’ve owned your rental property for several years you might be fooling yourself.  You probably made a good investment when you first bought the property.  But does it measure up today? 

Depending on how long you’ve owned your property, it might not be a good investment anymore.  I didn’t say not a good property; I said it not a good investment.  Read on to find a simple way to determine if your property is still measuring up.  You may be in for a surprise!

First, let’s quickly review the four financial benefits of owning investment real estate:

1.  CASH FLOW:  After you pay all expenses and loan payments, cash flow is the money left over.

2.  PRINCIPAL REDUCTION:  The loan is paid down with money collected from tenants.

3.  INCOME TAX SAVINGS:  IRS rules allow property owners to take depreciation deductions, which shelter the cash flow and principal reduction.  Any leftover depreciation creates a paper loss, which, in most cases, can be used to shelter other income – such as salary from your job.

4.  APPRECIATION:  Over time, the property increases in value.

These four benefits are powerful! You earn tax-sheltered cash flow, your tenants buy you the building, you get to tell the IRS you’re losing money, and all-the-while, the property goes up in value.  What a country!

So why am I challenging you to reconsider whether your property is still a good investment?  Simple!  Your "return on investment" is probably low – and getting lower by the year!

Let me show you an example.  Don’t get all tangled up in the numbers.  You can scale the numbers up, or down, depending on the actual prices in your particular real estate market.  But for now, just concentrate on the big picture and how it applies to you.

Return on Investment Drops from 18% to 7%

Assume you bought a rental house sixteen years ago for $70,000.  You invested $10,000 and borrowed the rest. Your goal is to retire in fifteen years and use the rental house to provide retirement income. 

So, how good was your investment sixteen years ago?  Let’s total your benefits.  Assume the cash flow, principal reduction and tax savings added up to $1,800 that first year.  You were earning 18% ($1800/$10,000) on your investment.  Not bad.  Plus the rental house was appreciating.  You’re an investment genius!

Fast-forward sixteen years to the present.  Today your rental house has appreciated to $120,000.  The yearly cash flow has increased to $5,000 and the principal reduction is $2,000; a total of $7,000 – just from the first two benefits!  

However, because you’ve owned the property so long, the depreciation deductions (assume they’re $3,000) are no longer enough to shelter the $7000 of cash flow and principal reduction.  That leaves $4,000 of unsheltered (taxable) income.  Instead of saving tax, you have to pay tax.  If you’re in a 35% bracket, (combined federal and state), you pay $1,400 tax.

So, your benefits from the rental house today look like this:  $5,000 cash flow, plus $2,000 principal reduction, minus $1,400 tax paid.  A total of $5,600.

It’s no wonder you consider yourself an investment genius if you measure the $5,600 against your original $10,000 investment: that’s a 56% return.  But that’s where most people go wrong! 

Your original investment has nothing to do with today’s rate of return! 

Your investment is not the amount you originally invested years ago. You’ve got way more than $10,000 invested today!  Your investment is the amount you could get out of the property if you sold it today.  That’s called your "net equity."

Over the past 16 years, your property has increased in value and your mortgage has been paid down.  The current difference between the property’s net value and your mortgage balance is likely to be $80,000 (or more).  In other words, if you sold the property today, you could walk away with $80,000.

However, if you keep the property, you’re, in effect, re-investing the $80,000 into the property.  Now, how does your investment look?

Not so good.  You’re earning $5,600 in benefits on an $80,000 investment – that’s only 7%.  What if I called you up and said, "I’ve got a great real estate investment for you.  You’ll earn a measly 7%."  You’d hang up on me!  Well, you already own it!

What if you did this instead?  Use your $80,000 equity as the down payment on a different property – one that produces18%?  With that down payment you could probably afford a $400,000 rental property.  Once you’ve owned that property for a few years, your equity will have grown again (and your rate of return fallen), so you repeat the process.  The goal is to maintain the highest possible rate of return.  You accomplish this by wisely moving your equity, from property to property.

Just for fun, take out your calculator and figure how much money you’d have in fifteen years if you leave the $80,000 invested at 7%.  Then calculate what $80,000 invested at 18% grows to in fifteen years.  I could give you the answer but you might not believe me, check for yourself . . . it’s gigantic!

Three ways to move your equity

Here’s a key point.  If you decide it’s time to "move your equity,"  be sure to explore all your options.  There are three common ways to move equity:

1.  SELL:  You could sell your current property and buy another.  The problem with selling is you have to pay capital gain tax.

2.  REFINANCE:  You could refinance your current property and use the loan proceeds to buy another property.  The problem with refinancing is you’re probably not able to borrow the entire $80,000 equity.
3.  EXCHANGE:  The third, and best, way to move your equity is to exchange.  Exchanging allows you to move your entire $80,000 net equity to another property without paying tax.  It’s wealthbuilding’s most powerful tool.

So, what does this all mean?  Well, if you own rental property, congratulations.  Your investment brilliance shines brightly.  However, the longer you own that property your glow begins to diminish.

The wise thing to do is re-evaluate your property – every year.  In essence, make the decision to "re-buy" the property.  As soon as the rate of return on your equity could be higher in another property, it’s time to take action.  And keep your brilliance shining brightly.

Copyright Tom Lundstedt Seminars
Reprinted with permission from the author

Tom Lundstedt "Calculate Return on Equity"

Have you owned your Rental Property too long? Learn how to calculate return on equity.

Tom can be reached by phone at 920-854-7046.

Students of a Lundstedt workshop invariably rave about how much they learned—and how much fun they had doing it! As one person recently said: “Every time I attend one of Tom’s seminars, I know I’ll leave with solid information I can use immediately!”

Tom Lundstedt’s seminars  are as entertaining as they are information-packed.They cover a wide range of topics, including:

Seminar #1:	Seven Key Tax & Financial Issues Every REALTOR® Should Know
Seminar #2:	How To Build Wealth by Investing in Real Estate
Seminar #3:	Use Your IRA to Invest in Real Estate
Seminar #4:	Exchanging Made Easy: How To Profit from Real Estate’s Best Kept Secret
Seminar #5:	You Want How Much???: How to Determine What a Rental Property is Really Worth
Seminar #6:	Pay No Tax When You Sell Your Home, Farm or Rental Property
Seminar #7:	How To Double Your Income by Working with Investors
Seminar #8:	Investment Real Estate for the First-Time Investor
Seminar #9:	Small Town Investment Real Estate: How To Analyze, List & Sell It
Seminar #10:	How Home Owners Can Benefit from The Tax Laws
Seminar #11:	Big League Hardball: An Advanced workshop on Commercial-Investment Real Estate
Seminar #12:	Exchanging: An Advanced Workshop for Commercial-Investment REALTORS®
Seminar #13:	How To Analyze & Value Investment Real Estate
Seminar #14:	Money, Taxes & The Real Estate Agent
Seminar #15:	How To Invest in Single Family Houses
Seminar #16:	Vacation Homes & the IRS

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