Why A 1031 Exchange Is Good For The Client And Good For The Broker
Why is recommending an exchange a good business practice for real estate brokers?
A more concrete way in which an Exchange benefits the broker, as well as the client, is the fact that an Exchange allows an Exchanger to purchase replacement property using that portion of the proceeds that would normally be used to pay a capital gains tax. For example, a sale of a property for $500,000, with a basis of $100,000, could result in a combined state and federal capital gains tax of approximately $100,000. There are a lot of variables that can affect the exact tax consequence, but consider that when properly leveraged, the seller of this property has lost approximately $400,000 in buying power. Buying power which could be used to acquire property of considerably more value than if the tax consequences were recognized. The tax savings achieved by completing an Exchange, allows more funds to become available for the purchase of replacement property. The higher the value of the replacement property, the greater the commission realized by the real estate broker.
Additionally, in a tight market there are many potential sellers who refuse to sell because they do not want to pay the capital gains tax associated with the sale. An Exchange is the tailor made solution for these potential clients. A scenario that normally excites a potential seller is where their property, which is located in a hot market area, can be Exchanged for property in a developing market, without a capital gains tax liability. This allows a client to take advantage of a strong market, and not have to worry about overpaying for a replacement property in the same market. Or when a client is informed that they can Exchange out of a management intensive property into a more passive investment such as a tenant in common share in a triple net leased property. Informing clients of the benefits of Exchanging helps create your own inventory.
You may also wish to consider the client who draws out the process of purchasing a replacement property. All the benefits associated with an Exchange do come with a few restrictions, some of which actually benefit the real estate broker. Identification rules make it easy for Exchangers to chose multiple properties that they might purchase, but the fact is, once their 45 day identification period is up, the Exchanger’s choices on that list are set in stone. The way in which these rules benefit the broker is that the client must make up their mind within the time restrictions given. The client has all the time in the world before the sale of the relinquished property takes place, and 45 days from that date to identify potential replacement property. Once the 45 days are up, the broker’s job is done, and the client must buy at least one of the properties which it identified or face a tax consequence. You now have the most motivated client you could ask for.
In conclusion, it is important to remember that a client’s advisors are sometimes in the best position to see solutions that the client is unaware of, or just too close to the transaction to realize. It is all to often the case that each professional advising a client thinks one of the other professionals took the time to discuss an important issue. In order to properly advise a client, a real estate broker should have a basic working knowledge of Tax Deferred Exchanges, and be able to recommend at least one attorney and one accountant who can properly advise the client, and the services of a reputable Qualified Intermediary. Remember, your client will always be grateful to you for making them aware of the benefits of an Exchange. The danger lies in not exploring the possibilities.