At 1031 Exchange Coordinators, we are often asked the pros and cons of doing a 1031 exchange. Whenever I get this question, I have to frame the question in the context of the given current market. As such, given the context of the real estate, political, and banking markets as of right now – Fall 2010 – here are the Top 3 Pros and Cons of doing a 1031 exchange.
First, why you should be doing a 1031 exchange right now:
1. Real estate prices. With the real estate market being as down as it has been over the last few years, property values have gone down considerably. It can be argued that as much as the market was overvalued in 2006 and 2007, the market may well be just as undervalued now in 2010. This simple fact allows any person who can reasonably value property to get a great deal right now on property and exchange their poor performing investment property into a new property.
2. Interest rates. With interest rates lower today than they have ever been, right now really is a great time to take on new debt. It’s so cheap, that in getting into an undervalued property now, you will likely be making more than the loan’s interest rate.
3. Current tax laws. With the current tax laws set to sunset at the end of this year, there is a lot of uncertainty as to what will happen to many tax benefits – 1031 exchanges included. Knowing this, now may be one of the last times to be able to do a 1031 exchange. Don’t wait if you don’t have to!
Now, what are the 3 main reasons not to be doing a 1031 exchange right now?
1. Will you be able to obtain financing? As the mortgage industry has taken a beating for being too passé in its lending requirements previous to the economy slowdown, the industry is now much more stringent. More cash must be brought to the table, credit must be stronger, and cash reserves are more important to underwriters. Add to this heightened scrutiny the fact that 1031 exchange property will most likely need investment financing, which brings even greater scrutiny.
2. Low current tax rates. The government is looking at a whole host of scenarios in how it will tax Americans as the Bush tax cuts are set to end this year, but it is fairly certain that no matter what the government decides, tax rates are bound to go up for most taxpayers. Doing a partial exchange – the property purchased in the exchange is for less than the property sold and taxes are paid on the difference – may be wise as the taxes that must be paid out are likely to be at a lower rate in 2010 than in the future.
3. Better options than a 1031 exchange. There are investments in real estate that are taking advantage of the down market. Distressed owners who are willing to sell great properties at unusually low prices to get the properties off their books. Investors are seeing wonderful returns that overcome whatever taxes are due from getting out of a previously-exchanged property.
1031 exchanges have always been a great general investment for people. However, as is seen above, there are compelling reasons to not do an exchange, especially given the current market. Connect with us and we’d be more than happy to discuss your specific situation!