I live in northern NJ, where just about everything is overpriced. I see listings for commercial properties and the prices just dont make sense to me. There’s almost no monthly profit in the deals, and yet some are still being sold…
So I realized that the only way this can make sense is if these buyers are using the 1031 exchange, meaning that they must have smaller residential properties with equity in them that they roll over to buy a commerical property. This way they save on taxes and are able to generate cash flow.
Is my understanding of this correct? Is this the proper way of building commercial properties?
Your premise is either wrong or just misstated.
A 1031 exchange allows you to defer the capital gains of an income property for a property of “like-kind”, that is a another investment property…like several residentials for a commercial, or residentials for q small strip mall, or a strip malll for a small commercial…the key is it must be “like-kind”…
If the property that you get is less than the one you’re getting rid of, the difference (usually ‘cash’) is referred to as “boot” and you must pay the capital gains…
It is a way of building up to commercial properties…
there are a few key points to remember when doing the 1031 exchange.
Like Keith said, this is for the delay in paying capital gains tax.
for this to work you must
- trade one investment property for another. to do this you.
a. sell the property you have and the proceeds are then sent to a qualified intermediary. (you are not permitted to receive the money)
b. you must make a list of properties you are interested in buying i recommend3, any more than that and there is a 200% rule to contend with.
c. when you find a property, it must be equal in value or higher
d. ALL the proceeds from the sale must be invested in the new property.
so i fyou sold a duplex for 200,000 an wanted to buy a triplex worth 300,000.00
you could do so, if you invest all of the proceeds from the sale of the duplex in the purchase of the triplex.
there are more nuances, but this is the general picture.
What NJ might be alluding to is the possibility that a property owner trading up via a 1031 exchange may accept a less attractive deal (pay too much) on the traded up parcel simply to get the deal done and avoid capital gains on the original property. Given the time constraints of a 1031 exchange and the potential tax consequences of not successfully completing the deal there is potential for making a poor choice. Also, given sufficient equity trading up in the deal the buyer may overlook price to some degree knowing that the debt service on the new property won’t totally destroy the potential for cash flow.
Given enough equity, any deal will cash flow. If these buyers have enough equity in smaller residential properties, they may just want to get into commercial property, and the tax postponement and cash flow seems acceptable to the buyer.
I want to ask NJ how he is computing monthly profit. It seems to me that commercial properties usually require 30-40% for a down payment. Are you calculating monthy profit from 100% financing?
Other reasons a buyer might want to get into commercial property include the fact that commercial tenants take care of all of their own maintenance and landscaping, tax depreciation, or maybe they own a commercial business and are tired of paying a lease on someone else's building.