Investing in Real Estate

Real Estate Investing

Buying and owning real estate is both a satisfying and lucrative investment strategy. Monthly rent, equity, passive income, and tax breaks are some of the benefits of real estate investing. There are endless ways of investing in real estate, from securing a home mortgage to building rental properties. Unlike bond and stock investors, real estate investors can use leverage to acquire property by paying a portion of the property cost upfront and paying the balance plus interest over time.

Typically, a conventional mortgage requires the applicant to make a 20% to 25% down payment. However, in some cases, a borrower only needs a down payment of 5% to buy an entire property. Upon acquiring a mortgage, you control the property from the moment you sign the papers. Therefore, you can even take out a second mortgage and secure it with the same property.

If done right, real estate investing can be lucrative or even flashy. It can bring an additional income stream and help you to diversify your investment portfolio. If you have ever had a landlord, you would probably not want to be one. The unending phone calls from tenants can be draining. The good news is that the best real estate investments do not involve dealing with tenants directly. Here are some of the best real estate investment methods.

1.      REITs – Real Estate Investment Trusts

When it comes to investing in real estate, there are a number of different options available. Two of the most popular choices are REITs and 1031 Exchanges. So, what exactly is the difference between these two options?

REITs, or Real Estate Investment Trusts, are a type of investment that allows investors to pool their money together to buy and manage income-producing properties. One of the main benefits of investing in REITs is that they offer the potential for high returns. In addition, REITs are often less risky than other types of real estate investments, such as direct ownership of property.

1031 Exchanges, on the other hand, refer to a specific type of tax-deferred exchange that allows investors to trade one investment property for another without incurring any capital gains taxes. 1031 Exchanges can be an attractive option for investors who are looking to diversify their portfolio or upgrade to a better property. However, it should be noted that 1031 Exchanges come with a number of complicated rules and regulations that must be followed in order to qualify for the tax deferral.

So, which option is right for you? The answer depends on your individual investment goals and objectives.

REITs are a great way of investing in real estate without holding physical property. They are a great investment option for investors seeking real estate portfolio exposure without a conventional real estate transaction. A REIT is created when a trust or a corporation uses investors’ funds to acquire properties. Often compared to mutual funds, real estate investment trusts are companies that own commercial real estate like retail spaces, office buildings, hotels, and apartment buildings. REITs are a viable retirement investment because they pay high dividends. Investors who don’t need regular income can re-invest the dividends to expand their investments.

REITs are a great investment, but they are also varied and complex. Like stocks, some REITs are bought and sold on major exchanges, but some are not publicly traded. The type of REIT you invest in will be a big factor in determining the investment risk involved. Usually, non-traded REITs aren’t easy to sell and can be hard to value. Especially if you are a new investor, you should stick to publicly traded REITs that you can easily sell through a brokerage firm.

In order to maintain the REIT status, an organization must pay out 90% of its profits as dividends. By doing this, a REIT does not have to pay corporate income tax. Regular organizations are taxed on their profits and can then decide whether to distribute their after-tax profits to investors as dividends.

Like stocks, REITs are an excellent investment for investors who prefer regular income. Because they are exchange-traded trusts, REITs are highly liquid. An investor does not need a title transfer or the help of a real estate agent to cash out their investment.

If you are considering investing in REITs, you should differentiate between equity REITs and mortgage REITs. Equity REITs own buildings, while mortgage REITs offer to finance real estate and focus on mortgage-backed securities.

Pros

·       Pays dividends to investors

·       A long-term cash-producing lease

Cons

·       The leverage associated with conventional rental real estate doesn’t apply

 

2.      Investing in Rental Properties

You should consider purchasing rental properties if you intend to make a significant commitment to investing in real estate. Rentals have the possibility of appreciation over time and offer a steady cash flow. However, rentals are a labor-intensive method of investing in real estate. There are two main ways of investing in rental property: long-term rentals and short-term rentals.

Long-term rentals are designed to be rented for an extended period, usually at least a year. They provide a steady income source, but this will depend on the reliability of the tenants. You can invest in single-family homes or a multifamily property that you rent to others.

Short-term rentals often cater to rotating occupants, whose stay could be as little as one night. A good example is Airbnb. You can invest in a property solely meant for short-term rentals, and you can list your entire home or apartment when you are not in.

Investing in rental properties provides a great potential for profits. However, it also requires a lot of effort from the investor, especially if they’re also the property manager. For example, the investor must pay for ongoing maintenance of the property, find and vet potential renters, and take care of repairs and other issues that could arise. You can hire a property management company to reduce some of these headaches. When investing in rental property, the low-interest rates and resources available to primary residence investors are not available. Therefore, it is often more expensive to invest in rental properties.

Pros

·       Rental incomes maximize capital through leverage

·       Provide a regular stream of income

·       Rental property has the potential to appreciate

Cons

·       Potential vacancies could lead to reduced rental income

·       Tenants can cause property damage

·       Managing tenants can be hectic

 

3.      Crowdfunding Real Estate Platforms

If you don’t intend to take a more hands-on approach to real estate investing, you should consider crowdfunding real estate investment programs like Fundrise. These online real estate platforms allow wealthy investors to invest in a specific real estate development project instead of holding large, generic investment properties. Real estate crowdfunding platforms fund development projects using other people’s money (pooling funds from different individual investors). You have to commit to the investment for an extended period, usually a minimum of five years. You can still access your money before this period depending on the platform’s discretion. However, you might face an early withdrawal penalty.

Many online real estate investment platforms charge fees. You should consider all the applicable fees, including additional property management fees, because these could diminish your returns. Many online platforms have minimum investment requirements. Therefore, you may not qualify to invest in some platforms. The minimum investment often ranges between $500 and $25,000 or higher. Some platforms only accept accredited investors, meaning that an investor must have a net worth of $1 million without including the primary residence. An accredited investor should have a yearly income of $200,000 or a combined income of $300,000 together with the spouse.

Pros

·       You can invest in a single project or several projects

·       Geographical diversification

Cons

·       Investors incur a management fee

·       The investment tends to be illiquid, with a lock-up period

 

4.      Flipping Properties

You don’t have to own rental properties to be a real estate investor. Buying and flipping real estate property is a common investment strategy. However, like investing in rental properties, this investment strategy takes a lot of work. It means buying and upgrading properties before reselling them. You must know how to identify the best neighborhoods that allow you to sell at a premium.

House flipping involves construction and renovations. Therefore, you must be willing to incur out-of-pocket costs and take on a higher risk. Home flipping is not as easy as it might sound. You will have to obtain the relevant permits for major renovations. Sometimes, the remodeling costs will be higher than you expect, especially if you have to outsource some work or hire contractors.

You should look for homes that do not need major renovations to minimize the effort needed in flipping properties. The neighborhood matters a lot. Sometimes, the neighborhood you expect to be trendy in the future might never catch on, leaving you with a hard-to-sell home.

House flipping is the wild side of real estate investing. Real estate flippers differ from buy-and-rent landlords, the same way day trading is distinct from buy-and-hold investors. Usually, house flippers buy undervalued properties, which they sell within six months (usually at a profit.)

If a flipper is unable to offload a home within a short period, they might find themselves in trouble. Some flippers do not hold enough money for long-term mortgage payments. Most flippers make money by buying property, renovating it, and selling at a profit. Others buy a property and rent it out as they wait for prices to rise.

Pros

·       Flipping properties can provide quick returns

·       This investment ties up capital for a short period

Cons

·       Hot markets might cool unexpectedly

·       An investor must have a deep market knowledge

 

5.      Real Estate Investment Groups

If you would like to own real estate minus the headaches of running it, real estate investment groups, commonly abbreviated as REIGs, are a great option. REIGs are more like mutual funds that invest in rental properties. Typically, a company builds or buys apartment condos or blocks. Then, the company allows investors to buy the units, thus joining the group. You can own one or several self-contained units. However, the company that operates the investment group manages all the units, advertises vacancies, interviews tenants, and handles maintenance in exchange for a percentage of the monthly rent.

The units put together a portion of the rent to cater to unexpected vacancies. Therefore, an investor will still receive income even if their unit is empty. There should be enough money to cover the costs, provided that the vacancy rate doesn’t persist.

Pros

·       Provides both income and appreciation

·       Less involving than owning rentals

Cons

·       Investors incur fees similar to those associated with mutual funds

·       Vacancy risks

·       A risk of subjection to unscrupulous property managers

How Real Estate Compares to Other Types of Investments

Every type of investment has its advantages and disadvantages. Below is a look at how real estate compares to other types of investments.

        I.            Real Estate vs. Mutual Fund

It is easier to invest in a mutual fund than in real estate. However, real estate provides investors with a hedge against economic downturns that could cause other investments to deteriorate in value.

      II.            Real Estate vs. Bonds

Bonds are one of the safest forms of investments because investors will never lose money by investing in them. Real estate investments have a higher potential for making profits, unlike bonds. However, investing in real estate has a higher likelihood of losing money.

    III.            Real Estate vs. Stocks

The value of stocks can rise and fall quickly. Real estate is less volatile than the stock market. However, real estate is less liquid than stocks. You can easily sell particular stocks and access money faster than you would in real estate.

    IV.            Real Estate vs. CDs

Like investing in bonds, investing in CDs (certificates of deposit)is a safe investment option whereby you can never lose money. However, the potential gains from investing in CDs are lower than the potential returns of real estate investments.

Why You Should Invest in Real Estate

Investing in real estate is lucrative; it could help you realize major profits despite its potential pitfalls. To get the most out of your investment, you should research properties and neighborhoods. Here are some of the most important reasons to invest in real estate.

·       Great Returns

Real estate increases in value over time, meaning that you can sell it at a significant profit. However, the returns are not guaranteed. You must invest in the right property to realize good returns.

·       A Steady Cash Flow

Real estate investments are a great way to increase your monthly income. Whether you invest in commercial or residential real estate, you can always rent out the space to tenants. You will then receive monthly payments in the form of rent. However, you should be careful when choosing tenants. Ensure that you understand the tenant’s payment history. By doing this, there will be little risk that the tenant will stop paying rent at some point.

·       Portfolio Diversification

Adding real estate into your investment portfolio brings diversification. This means that you will have an upper edge during times of economic turmoil. Even when stocks are suffering because of an economic downturn, your investment might still be increasing in value.

·       Tax Benefits

Real estate investments come with tax advantages. For example, you can deduct certain expenses associated with owning property. The expenses include management fees, mortgage interest, property taxes, insurance, and the costs of ongoing maintenance.

·       Passive Income

Owning real estate gives you passive income, meaning that you don’t have to work to earn this money. For example, if you rent out single or multiple living spaces, the rent you receive every month is an example of passive income.

Other benefits include long-term security, the ability to leverage funds, a chance to build capital, and fulfillment & control.

Challenges that Real Estate Investors Face

Despite the many benefits of real estate investing, it also comes with potential risks and challenges.

a)      Starting Capital

A real estate investor needs a significant amount of capital to get started. Residential and commercial properties are not cheap. Sometimes, you have to apply for a mortgage loan to acquire these properties. Investing in CDs, stocks, and mutual funds requires less starting capital.

b)      Liquidity

Unlike stocks, real estate is not liquid. Once you invest in real estate property, you may have to sell the property to realize profits. Other investments like bonds and stocks are far more liquid. You can easily sell stocks to get some money.

c)       Location

Location really matters when investing in real estate. If your property is not located on an estate where its value is appreciating, its price is not likely to increase resulting in a bad investment. When investing in real estate, you should do thorough research on the property’s neighborhood.

d)      Time

The profits from a real estate investment do not come fast. You might charge rent to residential and commercial tenants; however, this income will mainly cover the costs of maintaining the property and your monthly mortgage payment. You can only realize big profits when you sell the property for more than you bought it. After acquiring a property, you must wait for several years for it to appreciate in value.

Should You Invest in Real Estate?

Many experts agree that real estate should be part of a well-diversified investment portfolio. Real estate does not closely correlate to bonds and stocks. Real estate also provides income from rent in addition to the potential for capital gains. However, the risks and costs of real estate investing can run high. Therefore, REITs are the best choice for people with limited income or who are not seeking to invest in a primary residence.

If you decide to start flipping properties or investing in rental properties, you should ensure that you are aware of the potential risks. You should also have a plan for how to earn back on your investment. Real estate is often illiquid in the short term. You must be willing to make a big financial commitment.

Final Thoughts

If you intend to invest in real estate, you should review the various types of real estate investments. Ultimately, the right way to invest in real estate depends on your risk tolerance and long-term investment goals. Remember, you are not limited to one investment type. You can choose several real estate investment strategies for the best returns. Now that you understand the ups and downs of real estate investing, you can proceed to invest in your first property. Provided you do the necessary research; real estate can bring you big returns.

source https://www.transfs.com/investing-in-real-estate/

Alternative Mutual Funds

Alternative mutual funds are SEC-registered, publicly-traded mutual funds that employ complex investment and trading strategies. Also called alt funds or liquid funds, alternative mutual funds hold non-traditional investments. As their name implies, alt funds seek to accomplish the fund’s objective through non-conventional investment and trading strategies. Alternative mutual funds invest in assets like leveraged loans, global real estate, start-up companies, commodities, and unlisted securities that provide exposure beyond the conventional stocks, bonds, and cash.

Understanding Alternative Investments

Any financial investment that does not fall into one of the categories of traditional investments is an alternative investment. Private equity or venture capital, managed futures, hedge funds, commodities, art and antiques, and derivative contracts are all examples of alternative investments.

Institutional investors or high net worth individuals/accredited investors hold most alternative investments. This is due to the investments’ complex nature, high degree of risk, and lack of regulation. Many alternative investments have high fee structures and minimum investments, especially when compared to standard mutual funds and exchange-traded funds.

Alternative investments have limited verifiable performance data that can be used to advertise to potential investors. Despite their high initial minimum and high investment fees, alternative investments have lower transactional fees due to low turnovers.

Compared to conventional assets, alternative investments are fairly illiquid. For example, it would be more difficult to dispose of an ancient gold coin compared to selling shares. Due to the lack of regulation, alternative investments could be prone to fraud and investment scams. It is important for investors to conduct extensive due diligence when investing in alternative investments.

Traditionally, alternative investments targeted institutional and accredited investors. However, the investments have become accessible to retail investors through alternative funds.

Alternative Funds Strategies

The strategies alt funds employ are often complex. They include hedging and leveraging through derivatives. Other strategies include short-selling and opportunistic strategies that change with the market trends. Alternative mutual funds could be single-strategy funds or multi-strategy funds. Single-strategy alternative funds may employ a market-neutral or absolute return strategy that involves using long and short positions in stocks to realize returns. Multi-strategy funds employ a combination of strategies such as arbitrage strategies and market-neutral strategies.

The main objective of alternative mutual funds is to generate above-market returns. They also help investors manage risks better with strategies designed to smooth out the market and provide greater portfolio diversification.

The Unique Characteristics of Alternative Mutual Funds

If you are considering investing in alternative mutual funds, you should be aware of the unique characteristics of the funds and the risks of investing in them.

Investments

Unlike the standard mutual funds, alt funds generally achieve their investment goals by investing in non-conventional investments. For example, an alternative fund may invest in assets like start-up companies, global real estate, or commodities like oil or gold. These assets provide a more diversified portfolio. The alternative investments also provide different returns than more traditional investments like stocks, bonds, exchange-traded funds, and cash.

Investment Objectives

Alternative funds include a wide range of investment objectives designed to meet different investment needs. Many alternative mutual funds aim at minimizing the fluctuations in the value of their investments and reducing the risks. They achieve these goals by using complex trading strategies and spreading their investments among different assets. Some alternative funds seek to generate higher returns compared to standard mutual funds with a similar benchmark.

Investment and Trading Strategies

Alt funds pursue non-traditional strategies than conventional mutual funds. For example, an alt fund may use complex investment and trading strategies like using derivatives, selling stocks short, or following a “market neutral” or “absolute return” strategy. Fund managers combine different investment plans to seek positive returns even when stock markets fall. However, these strategies could result in additional risks and higher costs than traditionally-managed funds.

How Alternative Mutual Funds Compare With Hedge Funds

Some investment plans employed by alternative mutual funds are similar to those of hedge funds. Therefore, alt funds are often sold or marketed as a “hedge-fund-like” investment option for retail investors. Nevertheless, alt funds differ from hedge funds in several ways:

Alternative Funds are Regulated

As standard mutual funds, alternative funds are regulated under the Investment Company Act of 1940. This act provides several safeguards. The protections include restrictions on borrowing and debt, limits on illiquid investments, and the requirement to allow investors to dispose of their shares at any time. However, these regulations do not apply to hedge funds. Hedge fund managers are free to pursue non-traditional investment strategies and investments. Therefore, hedge funds are riskier than alternative funds.

Accessible to Retail Investors

Unlike hedge funds, alternative funds are open to the public, meaning any investor can invest in them. Hedge funds are only available to qualified purchasers or accredited investors. Accredited investors are high net worth individuals who meet certain minimum income or assets requirements. Therefore, hedge fund investors are financially sophisticated and can bear the risks that come with investing in them.

Lower Investment Fees

Investors in alt funds pay lower fees than those who invest in hedge funds. Many alternative mutual funds have an annual fee of 2% or less of the fund’s asset. However, investors in hedge funds pay an asset management fee of 2% and a performance fee of 20% of any profits earned from the investment.

Factors to Consider Before Investing in Alternative Mutual Fund

Alternative funds have unique characteristics and risks. Before you invest in alt funds, you should ensure that you understand all the characteristics and risks to determine if the investment is right for you. Below are some of the factors that you should consider:

·       Investment Objectives

Different funds have different investment objectives. Some funds capitalize on management expertise in a certain area, such as investing in certain commodities. Other funds seek to provide diversification through exposure to foreign currencies, commodities, and other alternative investments. You should ensure that the alternative fund you invest in is in line with your investment goals.

·      Strategy Risk Factors

Alt funds could have additional market and investment risks that are not common with traditional mutual funds. This is because, unlike traditional mutual funds, alt funds use relatively complex trading and investment plans. The risks vary depending on the strategy being used. Some of the additional risks that are common include the use of derivatives and leverage, short selling, futures contracts, and swaps.

·       Operating Expenses

Alternative mutual funds may have higher operating expenses than the standard mutual funds. Alt funds pursue complex investment plans that require expertise and active management, leading to additional costs. The complex strategies may generate extra expenses.

·       Minimum Investment

Many alternative funds have minimum investments. For example, a fund may have a minimum initial investment of $10,000 or higher. Others may require investors to have a net worth of at least $1 million before investing. Before you get started, you should ensure that you meet the necessary investment requirements.

·       Structure

The contents of alternative funds’ structures are not always clear because many of the funds do not have a clear legal structure. You should do your best to find out about a fund’s objective and holdings. Ensure that you also understand how a fund functions in the capital markets.

·       The Fund’s Performance History

Before investing in a fund, you should understand how it has performed in the past. However, many alt funds have limited performance histories. Many alternative mutual funds were launched in 2008. It’s hard to tell how the funds would perform in a down market. The fund’s performance may be different from that of broad indexes like the S&P 500.

·       The Fund Manager

When investing in alternative investments, it is crucial to gather ample information on the fund manager. How long has the fund manager been managing the fund? What is the manager’s previous management or professional experience? You can review the fund’s prospectus to gather information about the fund manager.

Alternative Investments for Portfolio Diversification

There is a low correlation between alternative investments and standard asset classes. This low correlation means that alternative assets move in the opposite direction to stock and bond markets. This makes the assets suitable for portfolio diversification. Investing in non-conventional assets like oil, gold, and real estate provides a hedge against inflation. Therefore, many institutional funds like private endowments and pension funds allocate a portion of their portfolio to alternative investments.

The non-accredited investors have access to alternative investments through alternative mutual funds and ETFs. Because alternative mutual funds are publicly traded, they are registered under SEC and regulated by the Investment Company Act of 1940. An alt fund makes it easy for retail investors to invest in alternative assets that were previously costly and difficult for an average investor to access.

Conclusion

Alternative funds are not for all investors. They have high market risk, a high minimum investment, and high expenses. If you seek to diversify your investment portfolio, you can do so by investing in different categories, assets, and capitalization. You can also invest in focused areas like industrial sectors. You can include mutual funds or ETFs that incorporate alternative securities or strategies into your portfolio. Whatever strategy you adopt, always ensure that you do your research before investing.

 

source https://www.transfs.com/alternative-mutual-funds/

Hedge Funds vs. Mutual Funds

The main goal of investing is maximizing returns. With so many investment options available, it can be daunting to determine the best investment vehicle. Among the investment products available, hedge funds and mutual funds are the most common. Both funds provide investors with the benefit of diversification by allowing them access to a pool of investment funds. Both funds are also portfolios managed by a portfolio manager and aim to achieve high returns through diversification. Pooling of funds means that a fund manager or a group of managers use the investment capital obtained from multiple investors to invest in securities that align with a specific investment strategy.

 Hedge Funds

Like mutual funds, hedge funds have a basic pooled structure. However, hedge funds are provided privately; therefore, they take higher risk positions to obtain higher returns for established investors. As such, hedge funds may use leverage, options, short-selling, and other alternative strategies.

Hedge funds are managed more aggressively than mutual funds. Many seek to achieve returns in failing markets or take global cyclical positions. Even if hedge funds are built around the same concepts of investing as mutual funds, they are structured and regulated differently. Given that they offer their investment privately, hedge funds only allow accredited investors to build their fund structures. Regulation D of the 1933 Securities Act outlines that only accredited investors can invest in private hedge funds.

Accredited investors have advanced knowledge of financial market investing. They also have a higher risk tolerance than average investors. High net worth individuals are willing to bypass the standard protections provided to mutual fund investors for an opportunity to potentially earn higher returns. Hedge funds employ a tiered partnership structure that includes a general partner and limited partners.

Due to their private nature, hedge funds have great flexibility in investor terms and investing options. Hedge fund fees are much higher than mutual fund fees. They also provide less liquidity because they have a lock-up period and redemption allowances. During volatile market periods, some funds may even close the redemptions to protect investors from a potential sell-off in the portfolio.

It is important to ensure that you understand the governing terms and the fund’s strategy risks before investing in hedge funds. The agreement terms for hedge funds are not publicized like mutual fund prospectus. Hedge funds rely on a private placement memorandum, an operating agreement or limited partnership, and subscription documents to govern their operations.

Mutual Funds

Mutual funds are popular in the investment industry. MFS Investment Management created and offered the first mutual fund in 1924. Since then, mutual funds have evolved to offer investors various choices in passive and actively managed investments.

With passive funds, investors invest in an index for targeted market exposure at a minimal cost. Active funds allow investors to access an investment product that provides the benefits of professional portfolio fund management. According to Investment Company Institute (ICI), a renowned research giant, there were 7945 mutual funds as of Dec 31, 2019. The mutual funds accounted for $21.3 trillion in Assets Under Management, abbreviated as AUM.

The Securities and Exchange Commission heavily regulates mutual funds under two regulatory directives. The Securities Act of 1933 calls for a documented prospectus for transparency and investor education. The Investment Company Act of 1940 provides a framework for mutual fund structuring. Mutual funds can be open-end or closed-end funds.

Both open-end and closed-end mutual funds trade daily on the financial market exchange. Open-end funds provide different share classes with varying fees and sales loads. The open-end funds’ price daily at their net asset value (NAV), usually at the end of trading.

Closed-end funds provide a fixed number of shares in an initial public offering, abbreviated as IPO. Like stocks, closed-end funds trade throughout the trading day. Unlike hedge funds, mutual funds are available to all types of investors, including average investors. However, some funds may have minimum investment requirements that could range between $250 and $3,000.

Mutual funds are managed based on specific strategies. The complexity of the strategies can vary, but most mutual funds do not rely on derivatives or alternative investing. Because they limit the use of high-risk investments, mutual funds are more suitable for the mass investing public.

Similarities Between Hedge Fund and Mutual Fund

The differences between hedge funds and mutual funds are more than the similarities. However, the two funds have a few things in common:

  In both funds, the investors hire professional managers to invest and manage their money

Hedge fund and mutual fund managers select the securities to invest in and group them to create diversified investment portfolios for their clients

Both funds work by pooling funds from a large number of investors and investing them with the help of a fund manager for a predetermined fee

Hedge Funds vs. Mutual Funds – The Differences

Most investors, especially those new to investing, group hedge funds and mutual funds under the same umbrella. At a glance, the two funds can seem similar, but they are completely different. The key difference between hedge funds vs. mutual funds is that hedge funds focus on the big fish – they focus on high-risk, high reward investments. On the other hand, a mutual fund sticks to the shallow waters where the returns are smaller but more reliable and less risky. Below are the main differences between the two funds:

1.      Investors

Hedge funds are only available to sophisticated investors and high-net-worth investors (accredited investors). High net worth investors have a net worth of more than $1million, excluding their primary residence. They also have an annual income of more than $200,000 – the investor must have maintained this income for the last two years. The annual income level may vary from country to country. The minimum investment amount is higher for hedge funds than for mutual funds. Other hedge fund investors include large and sophisticated institutions with substantial investment experience. These institutions include foundations, pension schemes, university endowments, and insurance companies.

In the case of mutual funds, there is no restriction on investors – they are open to all investors, including retail investors. They also have a lower minimum investment threshold.

2.      Investment Strategy

Investment strategies differ from fund to fund. Hedge funds employ more aggressive and high-risk investment strategies than mutual funds. The managers aim to generate profits for investors, regardless of whether the market is going up or down. To achieve this goal, they use high-risk tactics like taking speculative positions in derivative securities and short-selling stocks. Mutual funds do not take these highly leveraged positions. Therefore, a mutual fund is less risky, but there is a limit on its potential returns.

3.      Investments

Mutual funds are limited, and a mutual fund manager can only invest in publicly traded securities like bonds and stocks. However, hedge fund managers are free to trade in anything they like, whether derivatives, stocks, real estate, public securities, Bitcoin, lottery tickets, or life insurance. The hedge fund industry is not highly regulated like the mutual fund industry.

4.      The Holding Period

The holding period for hedge funds can vary greatly, depending on the fund strategy. The holding period could be microseconds, like with HFT firms, to years like with Global Macro. However, with a mutual fund, the investors’ money is locked away for several years.

5.      Fees

Hedge funds charge both a management fee and a performance fee. The management fee is usually 2%, while the performance fee could range between 10% and 30% depending on the fund. Therefore, the better the fund performs, the higher the performance fee the investor pays. The “two and twenty” is the most common fee structure whereby an investor pays a 2% asset management fee and a 20% performance fee on the profits earned.

Many investors may be hesitant to accept this fee structure, given that the hedge fund managers earn the asset management fees regardless of how well the fund performs. The asset management fee could run into the millions. However, the managers mitigate this by having their own money in the fund. This aligns their interests with those of the hedge fund performing well. In recent years, the rising competition in hedge funds has caused compression of these fees. Therefore, only high-performing hedge funds charge the full “2 and 20” fee< structure.

Unlike hedge funds, mutual funds do not charge a performance fee. They only charge a management fee that ranges between 1% and 2%. Mutual fees are excessively regulated by the type and amount of fees they can charge. The management fee depends on the percentage of the money managed by the fund.

6.      Regulations

Mutual funds are heavily regulated on the period in which the earnings should be invested, the amount of capital that can be invested, and the overall investment strategy. However, no such regulations restrict hedge funds. The two funds operate under different legal and regulatory structures. Hedge funds are like a partnership between the investors and their hedge fund manager. Since they are not excessively regulated, managers have more latitude and can make riskier investments.

A mutual fund operates as a corporation, which the government heavily regulates under the Investment Company Act of 1940.

7.      Liquidity

Mutual funds are heavily regulated, and the law requires them to provide investors with the ability to sell (liquidate) on a daily basis. This is not the case with hedge funds. Hedge funds are lightly regulated and have no liquidity constraints. Therefore, an investor may only exit their investment quarterly and, at times, after a longer period.

8.      Long/Short Vs. Long-Only Investment

The long/short and the long-only are two distinct investment strategies. Typically, mutual funds employ the long-only approach, although there are some exceptions. Hedge funds also go short; thus, their name long/short funds. Hedge funds take the long/short approach to reduce the volatility of their portfolios. Hedge funds go long on undervalued stocks and go short on overvalued stocks.

Because mutual funds adopt the long-only approach, mutual fund investors are subject to the daily fluctuations of the market while hedge funds (long/short) experience much less fluctuation.

9.      Management Style

While investing in both funds, investors do not select the securities to be included in their fund’s portfolio. Instead, a management team or a fund manager chooses the securities. Hedge funds are actively managed, meaning that the management team or the manager can use their discretion in security selection and timing of trades. However, mutual funds can be either passively or actively managed. If passively managed, the fund manager does not use discretion in security selection and timing of trades. Instead, the manager matches the holdings with a benchmark index.

Which is Right for You?

Mutual fund investments provide an investor with a minimum return rate known as the risk-free rate. Hedge funds focus on maximizing the investors’ return on investment. An average investor might not have the minimum investment or high net worth needed to invest in hedge funds. For retail investors, a wide portfolio of mutual or exchange-traded funds, abbreviated as ETFs, would be a better option than hedge funds. Mutual funds are also more accessible and cheaper than hedge funds. However, for high-net-worth individuals with a high-risk tolerance, a hedge fund would be an ideal option. Whether you should invest in hedge funds or mutual funds will depend on your financial capability and your risk tolerance.

The Bottom Line

Hedge funds and mutual funds are pooled investment vehicles structured in similar ways because they combine funds from investors under the management of a professional fund manager and invest in a wide range of securities. However, there are many differences in costs, investment goals, and who is allowed to invest beyond these similarities. Hedge funds offer higher returns but are riskier. Most people, especially retail investors, are better off investing in a mutual fund.

source https://www.transfs.com/hedge-funds-vs-mutual-funds/

Understanding Hedge Funds

What Are Hedge Funds?

A hedge fund is not a specific type of investment; it is a vehicle for investment. A hedge fund pools money from investors to invest in costly, high-risk, but high-reward securities and other opportunities. Unlike mutual funds, hedge funds are not heavily regulated. They have more leeway, allowing fund managers to pursue investments and strategies that could increase the risk of investment losses.

Hedge fund managers use a wide range of strategies, including trading esoteric assets and buying with borrowed money in an effort to achieve high investment returns for their clients. Hedge funds are considered risky investments accessible only to accredited investors, usually high net worth individuals (HNIs) and institutions who can afford the high fees and the risks involved.

Understanding the Hedge Fund

Initially, hedge funds solely focused on hedging or minimizing the risk of an investment. The managers of conventional investment funds would devote a portion of available assets to a hedged bet. That’s an investment in the opposite direction of a fund’s focus. The hedge fund helped in offsetting any losses in the core holdings. For example, if a fund manager invested a large portion in a cyclical sector that thrives in a booming economy like travel, they would devote another portion of the assets to stocks in a non-cyclical sector like power or food companies. In case of unexpected losses, the returns of the non-cyclical stocks would offset the losses in the cyclical stocks.

Nowadays, hedge funds aim to increase returns rather than decrease risks. Even though their focus has shifted, the name hedge fund stuck. Many hedge fund managers have taken the concept of hedge funds to an extreme. The funds have nothing to do with hedging, except for the few managers who stick to the original concept of hedge funds, commonly known as the classic long/short equities model.

The Securities and Exchange Commission does not regulate hedge funds strictly as it does mutual funds. This means that hedge funds often use riskier ways and riskier investment strategies. They often use leverage, which is borrowed money to buy assets to multiply their potential returns (at times, losses). Hedge funds also invest in derivatives like futures and options. They are free to invest in esoteric investments that conservative conventional (other) investors would not touch. The appeal of many hedge funds mainly revolves around the reputation of their managers, who are considered stars in this industry.

These money managers charge high fees, usually 1%-2% of assets and a performance fee of around 20% of the profits. These performance fees encourage the money managers to take high risks. The more the money they earn, the higher the profits for them and their clients. The fund managers are paid on pure profit management.

Types of Hedge Funds

There are several types of hedge funds. They are categorized depending on the strategies they employ, including macro, relative value, equity, activism, and distressed securities.

·       A macro hedge fund involves investing in bonds, stocks, and currencies. Fund managers invest with the hope of making profits from changes in macroeconomic variables like countries’ economic policies and global interest rates.

·       A relative-value fund involves taking advantage of spreads’ inefficiencies or price.

·       An equity hedge fund is country-specific or global. It involves investing in lucrative stocks while avoiding downturns. Fund managers do this by shorting overvalued stocks and stock indices.

Other hedge fund investment strategies employed by fund managers include emerging marketing, aggressive growth, income, value, and short selling.

The History of Hedge Funds

Alfred Winslow Jones, a renowned Australian investor and financial writer, launched the first hedge fund in 1949. Jones launched the hedge fund through his investment company, A.W. Jones & Co. He raised $100,000, of which $40,000 was from his own pocket. He set up a fund that aimed at minimizing the risks in long-term investment by short-selling other stocks.

Currently, this innovation is known as the classic long/short equities model. Jones enhanced the returns of his fund by employing leverage. He converted the fund from a general partnership to a limited partnership in 1952. He added a 20% incentive fee to compensate the managing manager. Jones earned a reputation as the father of the hedge fund because he was the first money manager to combine the use of leverage, short selling, and a compensation system based on performance.

Hedge funds outperformed most mutual funds in the 1960s. Initially, they were unknown to the public until a 1966 article; Fortune featured a fund that outperformed every mutual fund on the market. As the fund evolved, most hedge funds turned away from Jones’s strategy and embraced riskier strategies. These moves resulted in heavy losses in 1969-70 and many hedge fund closures during the bear market in 1973-74.

For more than two decades, the hedge fund industry didn’t grow much. However, in 1986, an article in Institutional Investor highlighted the double-digit performance of Julian Robertson’s Tiger Fund. Once again, hedge funds captured public attention. Many high-profile money managers abandoned the conventional mutual fund industry in the early 1990s and became hedge fund managers.

From the late 1990s up to the early 2000s, history repeated itself. Many high-profile hedge funds failed, including the Robertson’s Tiger Fund.

Hedge Fund Industry Today

The industry experienced a comeback, recording a growth of total assets under management from $2.2 trillion in 2012 to $ 3.6 trillion in 2019. The number of hedge funds has also grown. In 2002, the number stood at around 5,000, and by the end of 2015, it was 10,000. That number had exceeded 16,000 worldwide by 2019.

Common Hedge Fund Strategies

The most popular hedge fund strategies include:

1.      Long/Short Equity

This strategy involves exploiting potential profit opportunities. Managers take into consideration both potential upside and downside expected price moves. The strategy involves taking long positions in relatively underpriced stocks and selling short stocks considered overpriced.

2.      Merge Arbitrage

Also known as risk arb, merger arbitrage involves simultaneously buying and selling stock of merging companies, creating riskless profits. A merger arbitrageur weighs the likelihood of a merger not closing on time or not closing at all.

3.      Equity Market Neutral

With equity market neutral (EMN), a fund manager exploits the differences in stock prices by being long and short on an equal measure in closely related stocks. The stocks may be within the same industry, sector, or country. The stocks could be historically correlated or just share similar characteristics like market capitalization. Managers create EMN funds with the intent of producing positive returns, irrespective of whether the market is bullish or bearish.

4.      Global Macro

This strategy involves basing holdings mainly on the overall economic and political views of different countries and their macroeconomic principles. Holdings could include fixed income, long and short positions in equity, currency, futures markets, and commodities.

5.      Convertible Bond Arbitrage

Convertible bond arbitrage strategy simultaneously takes long and short positions in convertible bonds and underlying stock. The arbitrageur adopts this strategy, hoping to profit from the movement in the market by creating a hedge between long and short positions.

6.      Volatility Arbitrage

With this strategy, the hedge fund manager attempts to make a profit from the difference between the forecasted future price volatility of an asset like a stock and the implied volatility of options based on the asset. This strategy involves employing derivative contracts and other options.

Advantages of Hedge Funds

Despite the high investment risks of hedge fund investing, they provide some worthwhile benefits over conventional investment funds. Their common benefits include:

·       Managers employ creative strategies that can generate high returns in bond markets, and rising and falling equity.

·       There is a reduction in overall portfolio risk and market volatility in balanced portfolios.

·       There is potential for higher returns than for conventional investments.

·       Hedge funds embrace a variety of investment styles, giving many investors an opportunity to customize their investment strategy.

·       Gives hedge fund investors an opportunity to access some of the world’s most renowned and talented investment managers.

Disadvantages of Hedge Funds

Investing in hedge funds comes with the following risks:

·       Compared to mutual funds, hedge funds tend to be less liquid

·       Concentrated investment strategies adopted by managers expose investors to potentially huge losses

·       Investing in a hedge fund requires an investor to lock up money for several years

·       The use of borrowed money or leverage could lead to significant losses

Who Can Invest in Hedge Funds

Hedge fund investors must meet certain income and net worth requirements. Due to government regulations, only “accredited investors” can invest in these funds. An accredited investor could be a person or an entity. An individual investor must meet the following criteria:

·       Should have a personal income of $200,000 or more per year – if the investor is married, they must have a combined income of at least $300,000 with the spouse. The investor must have maintained this income level for two consecutive years and must have a reason to believe that they will maintain this income in the future.

·       The investor should also have a personal net worth of $1 million or higher, alone or with a spouse. This net worth excludes the investor’s primary residence.

For institutional investors and entities to be qualified investors, they must be:

·       A trust with a net worth of at least $5 million – the trust should have been formed for the purpose of investment and should be run by a sophisticated investor.

·       An entity in which all equity investors qualify as accredited investors in their own capacity/merit.

According to the U.S. Securities and Exchange Commission (SEC), sophisticated investors are persons with ample knowledge and experience, which enables them to make informed decisions regarding the potential risks of an investment.

Factors to Consider When Investing in Hedge Funds

Hedge funds are not subject to the federal rules that protect standard investors. This makes them riskier than other investment options. If you are considering investing in them, you should:

Be an accredited investor – You can only invest in hedge funds if you are an accredited investor. This means that you should have a minimum level of income or assets.

Read and understand the fund prospectus – You should ensure that you read the fund prospectus and other materials to understand the level of risk involved. Ensure that the investment strategies and the risks involved are suitable for your investing goals, risk tolerance, and time horizons. Like with other investments, the higher the potential returns of a hedge fund, the higher the risks involved.

Know how fund assets are valued – Hedge funds can hold hard-to-sell investments. The investments can also be difficult to value. Before you invest, ensure that you understand the valuation process, including how independent sources value the fund’s holdings.

Understand the fees – Fees will have a significant impact on the return on your investment. Typically, hedge funds charge an asset management fee of 1-2% of assets and a 20% performance fee of the fund’s profits. Many managers take considerable risks to generate larger returns and, in turn, earn higher.

Know the restrictions on your right to recoup your shares – With hedge funds, investors have limited opportunities to redeem or cash in their shares, usually four times a year or less. A lock-up period of one year or more applies, during which investors cannot cash in their shares.

Choose a qualified fund manager –Ensure that you choose a fund manager who is qualified to manage your money. Before you invest, ensure that the fund manager has no disciplinary history within the securities industry.

Gather information – Gather ample information and ask all the necessary questions. When investing in hedge funds, you are entrusting your money to another person. You have a right to know where your money is going, how it is being invested and how you can recover it.

The Bottom Line

Like mutual funds, hedge funds are pooled investment vehicles, guided by professional management firms. However, they operate with far less disclosure and aren’t regulated as much. They involve pursuing flexible and risky strategies to make higher profits for investors and higher gains for managers. Unlike mutual funds, hedge funds have higher minimum investment requirements. The majority of investors in hedge funds are high net-worth individuals. Therefore, hedge funds have earned the reputation of speculative luxury for wealthy investors.

 

source https://www.transfs.com/understanding-hedge-funds/

1031 exchange 200 rule

The 1031 exchange rule is a tax code provision that allows investors to swap one property for another without having to pay capital gains taxes. It’s a valuable tool for investors who want to maximize their profits, and it can be especially helpful in a hot real estate market like the one we’re seeing today. Here’s what you need to know about the 1031 exchange rule, including how to use it to your advantage.

What is the 1031 exchange 200 rule?

In a 1031 Exchange, the 200% rule refers to the maximum dollar amount that an investor can exchange up for. In order to qualify for a 1031 Exchange, the Investor must identify replacement property or properties within 45 days of the sale of the relinquished property and complete the exchange within 180 days of the sale of the relinquished property. The identification of replacement property is made by either describing the property in a signed document or by actually purchasing the property. The deadline for identifying replacement property is firm, and if the 45th day falls on a weekend or holiday, the deadline is automatically extended to the next business day.

There are three different types of Replacement Properties: like-kind, downleg, and upleg. Like-kind property refers to a property of the same nature, character, or class. For example, an office building could be exchanged for another office building, but not for a shopping center.

The second type of replacement property, downleg property, is typically used in what is called a “Starker exchange.” A Starker exchange is an exchange in which the relinquished property and the replacement property are both held by different people at the time of the exchange. In order to qualify as a Starker exchange, the relinquished property must be sold to an unrelated party and the replacement property must be acquired from an unrelated party.

The third and final type of replacement property, upleg property, is when the investor acquires more than one piece of replacement property in exchange.

Buying more than one replacement property in a 1031 exchange?

When looking to purchase more than one property in a 1031 exchange, you must adhere to the 200 percent rule. This rule states that the fair market value of the property or properties you are exchanging must be at least 200 percent of the fair market value of the property or properties you are selling. Therefore, if you are selling a property for $100,000, you would need to purchase a property or properties worth at least $200,000 in order to complete a 1031 exchange.

When it comes to purchasing multiple properties in a 1031 exchange, there are two main options: the simultaneous exchange and the delayed exchange. In a simultaneous exchange, both the sale of the relinquished property and the purchase of the replacement property must take place on the same day. In a delayed exchange, there is a period of time between the sale of the relinquished property and the purchase of the replacement property.

If you are planning on purchasing multiple properties in a 1031 exchange, it is important to consult with a qualified intermediary early on in the process. A qualified intermediary is a neutral third party who assists in facilitating 1031 exchanges. They can provide guidance and assistance throughout the entire process, ensuring that everything is completed correctly and in a timely manner.

Understanding Replacement Properties in a 1031 Exchange

In order to defer your capital gains taxes, you need to reinvest the proceeds from your sale into “like-kind” property of equal or greater value. But what exactly does that mean? Here, we explain the IRS’s definition of like-kind property and how to find replacement properties that will qualify for a 1031 exchange.

What Is Like-Kind Property?

The IRS defines like-kind property as an investment or business property that is similar enough in nature, character, and use to be considered equivalent. For example, you could exchange one rental property for another rental property, or exchange an office building for a retail center. The key is that the new property must be used for the same purpose as the old property.

Like-kind property does not need to be of equal value, but the exchange must be of equal or greater value in order to defer all capital gains taxes. For example, let’s say you sell a rental property for $1 million and use the proceeds to buy a new rental property for $900,000. In this case, you would still owe capital gains taxes on the $100,000 difference.

In order to qualify for a 1031 exchange, you need to identify your replacement property within 45 days of selling your original property and close on the purchase of the new property within 180 days (or before your tax return is due, whichever comes first).

To find replacement properties that will qualify for a 1031 exchange, investors must follow the “200% Rule.” as we previously mentioned. As a reminder, this rule states that an investor must identify two or more potential replacement properties, with a combined value that is equal to or greater than the value of the property being exchanged.

To find these properties, investors can use online resources like the 1031 Property Finder. This website allows users to search for properties by state, price range, and type of property.

Once an investor has found a few potential replacement properties, they should reach out to a qualified intermediary (QI) to help facilitate the exchange. A QI is a neutral third party who holds onto the proceeds from the sale of the original property and facilitates the exchange.

working with a QI, the investor will have to fill out a “Like-Kind Exchange Agreement” which outlines the terms of the exchange. This agreement must be signed by both the investor and the QI.

The last step is to close on the replacement property. The investor will use the proceeds from the sale of the original property, which is being held by the QI, to purchase the new property.

When it comes to 1031 exchanges, the relinquished property value is typically determined by an independent appraiser. However, the IRS may also determine the value of the property if they feel that the appraised value is not accurate. In order to ensure that the relinquished property value is fair and accurate, it is important to have a professional appraiser assess the property. This will help to provide peace of mind and avoid any potential issues down the road.

Once the exchange is complete, the investor will own two investment properties that can be used for future exchanges down the road.

Why is it necessary to identify replacement property?

If you want to complete a 1031 exchange, you must identify the replacement property that you intend to purchase within 45 days of the sale of your original property. This may seem like a short timeframe, but it is essential in order to keep the 1031 exchange process moving forward.

There are a few different ways that you can identify replacement property. The first way is to simply list the potential properties that you are interested in purchasing. This method is typically used when there is only one buyer and multiple properties being considered.

The second way to identify replacement property is through a Multiple Property Identification Notice (MPIN). This notice lists all of the properties that are available for purchase as part of the 1031 exchange.

The third way to identify replacement property is through a Notice of Contract Acceptance (NCA). This notice is used when there is only one buyer and one property being considered.

It is important to note that you are not required to purchase all of the properties that you identify. You can narrow down your choices as you move forward in the process. However, it is essential to have a clear idea of what you are looking for before moving forward with the 1031 exchange.

There are a few different reasons why it is necessary to identify replacement property. First, it allows you to keep track of the potential properties that you are interested in. Second, it helps to ensure that you are making progress in the 1031 exchange process. Finally, it allows you to make an informed decision about which property to purchase.

Identifying replacement property is an important step in the 1031 exchange process. By taking the time to do so, you can make sure that you are on track to completing a successful exchange.

What is the 95% rule in 1031 exchange?

In order to defer paying taxes on the sale of an investment property, you may be able to do a 1031 exchange. In order to qualify for this exchange, you must reinvest the proceeds from the sale into a “like-kind” property.

The 95% rule in 1031 exchange states that in order for the exchanged properties to be considered “like-kind”, at least 95% of the value of the new property must be derived from real estate. This means that if you are selling a rental property and want to use the 1031 exchange to purchase a vacation home, it would not qualify as the new property would not be considered like-kind.

However, there are some exceptions to this rule. If the property being exchanged is held for productive use in a trade or business, or for investment, then it can be exchanged for another property that is of a like-kind, even if the new property is not used for the same purpose.

For example, let’s say you own a rental property that you want to sell. You could do a 1031 exchange and purchase a vacant lot as your replacement property. Even though the vacant lot would not be considered “like-kind” under the 95% rule, since it is being purchased for investment purposes, it would still qualify for the 1031 exchange.

The bottom line is that if you want to do a 1031 exchange, make sure you are aware of the rules and regulations in order to avoid any penalties.

source https://www.transfs.com/1031-exchange-200-rule/

1031 exchange multiple properties

The basic rules of section 1031 in a 1031 exchange mandate comparison of two properties to determine their like-kind nature and the gain recognized. However, there is an exception for multiple properties exchange by creating several exchange groups. Swapping several properties is also possible in a structure of an exchange of multiple properties within a single exchange group. Like with every 1031 exchange, potential downsides and rules exist.

Can you do a 1031 exchange with multiple properties?

Section 1031 does allow for more than one exchange – there can be multiple ones that prevent putting all your eggs in one basket. That exchange structure works in two ways: investors can have one relinquished property with several properties as a replacement or multiple relinquished properties with a single replacement property.

That variation of one-to-one 1031 exchange is slightly more complicated, but it also brings more tax benefits and diversifies real estate investments. Working with an experienced, qualified intermediary can help you navigate the complexities without hitches.

Can I exchange a single property for multiple properties?

Exchanging a single relinquished property’s value for many replacement properties is the most popular scenario for investors. It occurs when real estate investors sell a value-based asset that they replace with multiple properties. These exchanges are particularly gaining ground across the U.S. in recent years and are growing. They can help you make 1031 transactions for two properties.

An example of selling one property for multiple replacement properties

Assume an investor owns Seattle Property. In recent years the value of the city has risen from an average valuation of around $356,000 to approximately $826,000. Although the investor uses the home as an investment property with steady cash flow, they want to increase the real estate income for retirement reasons.

The taxpayer decides to engage in a 1031 exchange rather than sell the property and incur capital gains taxes. They relinquish the property at a higher price of $900,000 and identify two properties at lower prices of $360,000 each in another city. After paying for the replacement properties, that investor will have $180,000 as capital boot. Since that amount is taxable, the taxpayer can explore other options that allow tax deferral. They can identify another single property worth that balance to the qualified intermediary or use the money in the 1031 improvement exchange – another form of tax-deferred exchange.

How many replacement properties can you have in 1031?

There is no limit to the multiple replacement properties you can identify, but investors should consider their practicality and other unique factors surrounding the exchange. You can select as many replacement properties as you like, but you must remember to stay within the identification rules. The strict time limits make any exchange challenging enough, and it gets worse when you are dealing with multiple properties instead of one. Consider the rules too.

The identification rules for a 1031 exchange for multiple properties

Exchanging one asset for many replacement properties has independent rules that may seem more challenging for most people, but they are as straightforward as those in 1-for-1 trading.

The 95% rule in a 1031 exchange with multiple properties

The 95% rule allows investors to identify replacement properties with unlimited value or relation to the relinquished property closing costs. However, you must close on 95% of the identified value or lose the tax deferral.

Note that the 95% rule is connected to the 200% rule, meaning there should be joint consideration. Failure to impose the 200% rule and identify multiple properties that meet or exceed the relinquished property’s aggregate value before 180 days elapse can lead to a taxable boot event.

For instance, an investor that wants to sell a real estate property at $1.2 million can identify more than three rental properties within 45 days. If the properties identified are worth $1.5 million, the investor must close on real assets worth $1,425,000 – 95% of the total value. Otherwise, the exchange becomes invalid.

The three-property rule in a 1031 exchange with multiple properties

The three-property rule requires that you can list three alternative homes within 45 days of selling a relinquished property. Investors must send the corresponding e-mail addresses to the 1031 exchange agent – a qualified professional.

The timeline includes holidays and weekends, meaning taxpayers do not get a workday grace period. You must also close on the replacement properties within 180 days. The rule does not limit the number of properties you can identify. However, 95% and 200% rules can apply when an exchanger identifies five properties or more simultaneously.

The 200% rule in a 1031 exchange with multiple properties 

The 200% rule requires investors to locate multiple replacement properties that do not exceed 200% of the relinquished properties value.

Investors should remember the association with the 95% rule. It also helps to note that the 200% rule means that the aggregate fair market value of the replacement properties should not be more than double the relinquished property’s total value.

Can you do a 1031 exchange with multiple relinquished properties?

The Internal Revenue Service does not limit investors on the number of relinquished properties they can sell through the 1031 exchange. One of the challenges you are likely to experience is the 45-day identification time limit. The time starts lapsing immediately after closing on the sale of the first relinquished property. The accommodator must also purchase the other investment within 180 after giving up the relinquished property.

The 95%, 200%, and three-property rules also apply for investors selling multiple properties using 1031 exchange. That means you must consider their total aggregate value before deciding. Weighing the benefits of dealing with multiple relinquished properties against one replacement property and considering the downsides of each can help you make the best decision. You can also consult a qualified professional like a tax advisor or experienced qualified intermediary.

1031 exchange of multiple properties for a single property 

Combining multiple (up to three) properties into one property with higher value may be riskier, but you can meet your investment objectives. Start by negotiating the replacement property value before completing the other sale. You can also plan the structure to ensure the purchase of the replacement property coincides with the closing sale of the relinquished properties.

Example:

An investor can have more than three properties in San Diego and other cities in LA. Managing those properties and visiting those places can be hectic. An alternative is to find a commercial property with the combined values of the other three properties and use a 1031 exchange. For instance, if the other properties are $700,000 each, the taxpayer can find one property that sells for $2.1 million. Apart from enjoying the tax-deferred exchange, the investor can also gain better cash flow from such an exchange.

Benefits of Exchanging Multiple Relinquished Properties

There are many benefits of using several relinquished properties for a single desired replacement property, but the main one is significant cost reduction. Having multiple people to manage multiple properties is expensive. One real estate agent can charge 10% of the rent they collect. That means the amount increases when they are many. Swapping those properties in a single exchange can boost cash flow.

The time it takes to manage multiple properties can be used to explore other real property investments.

Selling multiple properties creates a chance to get into a different, perhaps lucrative, class of commercial properties. The NNN lease means renters cater to maintenance costs, real estate taxes, and insurance premiums. Saving costs by not hiring agents also adds to the cashflow.

The best way to ensure your exchange is legal and safe

The services of a qualified intermediary are mandatory in a tax-deferred exchange regardless of how many properties you want to swap. It can be a 1031 exchange company with expertise on the subject matter. You can also get a tax advisor to elaborate on the options for minimizing tax boot while maintaining the aggregate fair market value for the other assets.

Additional strategies

The exchanger can delay closing on the first few properties. That can provide leeway for the parties to agree on the property sales for a short period.

You can use a reverse exchange structure where an exchange accommodation titleholder purchases the replacement property before the relinquished property is sold. The option eliminates the time limits occasioned by delayed exchanges, but it is a costlier alternative.

A partial reverse exchange can also help. The exchanger can close on the first relinquished property after identifying potential replacements. The intermediary can also use the same exchange structure to close the replacement property before the second relinquished property is sold. That allows the setup of a regular exchange followed by a reverse exchange that allows several sales while extending the timeline for the whole process.

Investors can hold the desired replacement property hostage until negotiation and closure of the relinquished properties’ sale at roughly the same time.

How can a 1031 exchange expert help?

1031 exchange experts are known as qualified intermediaries, accommodators, or facilitators. They facilitate the exchange process and take a portion of the proceeds as their payment.

A taxpayer cannot accept the funds in a reverse exchange or delayed exchanges. The expert holds the transaction rights and handles the process on the investor’s behalf. The experience and knowledge that the experts have can minimize if not eradicate errors.

Timeline concerns in a 1031 exchange with multiple properties

The 180-day exchange period and the 45-day identification period will trigger once you sell the first of the multiple properties on which the property is available. That means you should carefully choreograph your sale of the properties involved to make sure they are sold during this period. Failure to identify or close a new home within a 45-day identification period can impact the benefits of a taxable deferral.

What role does NNN lease play in a 1031 exchange with multiple properties?

An NNN lease transfers maintenance, utilities, and repair responsibilities to the tenant. It is suitable for people who want to exchange multiple properties for one replacement property with the same value.

The role of Delaware Statutory Trust in a 1031 exchange with multiple properties

A Delaware Statutory Trust is a structure that works for those interested in commercial investment. DST allows the sale of a fractional interest.

The statutory trust can benefit investors with multiple properties they can relinquish, but cannot quickly identify a single replacement property. You can defer capital gains by giving up only the fractional interest.

source https://www.transfs.com/1031-exchange-multiple-properties/

1031 Exchange Cost

Closing Costs and the Tax Deferred Exchange

The internal revenue code does not have many regulations about 1031 exchange costs. How to handle such expenses and costs remains unclear. For instance, despite the general rule involving the exchange of relinquished property and replacement property, it is unknown whether the exchanger has to deal with a taxable boot on the exchange funds.

How much does a 1031 exchange cost?

A direct cost that exchangers incur when using 1031 exchange goes to the qualified intermediary (QI). Such fees differ, but reports usually indicate the typical 1031 delay is between $650 and $1200. The exchanger may also incur additional operating expenses. A QI may also offer an overnight delivery charge for documents that need a fast response. That only happens with a simple deferred exchange. Complex ones can be more expensive.

Qualified intermediary fees

The role of a qualified intermediary

According to IRS regulations, 1031 exchanges must include a third party. That is where the services of a qualified intermediary become mandatory. They transfer the relinquished property to the buyer and hold on to the funds until the exchanger finds a replacement property. They are also responsible for acquiring the new property and transferring it to the taxpayer. In short, they facilitate transactions during the exchange process.

How much does an intermediary cost for a 1031 exchange?

Third parties play a significant role in every 1031 exchange. That is why they can get up to two-thirds of the exchange costs and interests.

Delayed exchange costs

Qualified intermediaries can be non-institutional or institutional. The former are independent companies that do not have affiliations with title companies, while the latter do.

Non- institutional intermediaries are slightly cheaper, with the average 1031 exchange costs ranging between $600 and $800. Their institutional counterparts cost from $800 to $1200.

The qualified intermediary fees in the delayed exchange cover administrative, accommodation, and qualifying fees, such as document preparation, processing costs, notary, and other additional fees.

Other costs you may also incur include additional property fee that ranges from $300 to $400 and opportunity cost that applies when the IQ keeps the interest on the escrowed funds. Interest income mainly applies when the exchange proceeds from the relinquished property remain in the escrow account for more than 180 days before closing on the replacement property.

Reverse exchange fees

Reverse 1031 exchange, also known as construction 1031 exchange, costs more. The exchange structure means buying the replacement property before completing the sale of the relinquished property or closing statements. The process is more complicated because most investment properties are available where demand exceeds supply.

Since there is no significant interest income when dealing with a reverse exchange, qualified intermediary’s fees are higher – between $3000 and $8000. You save on foregone accrued interest but spend more directly out of pocket.

Interest income: How a qualified intermediary makes most of their money

The most significant 1031 exchange expense that taxpayers incur directly is the setup cost, which is 1/3 of the total qualified intermediary fees. The rest of the exchange expenses are interest-based. The QI holds the exchange proceeds from the first property until the purchase finalization of the investment property. During that time, the net proceeds can be gaining interest in money market setups or other deposit account types. All that money goes to the QI.

You have 180 days to finalize the purchase contract of the second property after completing the sale contract of the first. The interest money can accumulate to a lumpsum amount.

1031 Exchange Cost – 1031 Exchange transactional costs 

1031 Exchange generally includes various expenses necessary for making exchanges possible. Although these expenses are essential parts of an exchange transaction, certain costs paid from sales, 1031 exchange proceeds may or may not cause tax consequences for an exchange.

Are there closing costs on a 1031 exchange?

Closing costs are available in every 1031 exchange – the only difference is whether they lead to a taxable event. According to the internal revenue service, non-transactional costs in the 1031 exchange do not count as expenses. Regulations surrounding other non-exchange expenses remain ambiguous, meaning real estate investors should be cautious dealing with them and distinguish when to cover some of those costs out of pocket.

Here are some typical allowable closing costs in 1031 exchanges compared with cost attribution metrics:

Allowable closing costs

Appraisal fees for purchase contract: Appraisal fees range from $5000 to $10000 depending on whether it is a large office building or an average-sized one. The costs differ from the charges by mortgage lenders.

Escrow fees: The escrow fee differs depending on available additional fee requirements. You may pay between one and two percent of the sale price.

Tax advisor and attorney fees: Tax advisors and attorneys are responsible for ensuring you remain protected throughout the 1031 exchange process. They set up the swap and monitor the post-exchange process to ensure you do not encounter legal issues. They charge a flat fee that can be more than $100,000.

Title insurance: Title insurance premiums, title company fees, document preparation costs, title closing fees, and deed recording can cost 1% of the property sale price.

Real estate broker commissions: Broker commissions are not flat fees. The amount varies with the size, type, and location of the property. Exchangers can spend 5% to 6% of the final cost of investment property, with the amount shared between seller and buyer agents.

Inspection fees: Most inspectors charge $0.1 per sq. ft., but that can change with the property state.

Transfer taxes: Transfer taxes are a portion of the value of the exchange funds. You can calculate the amount during property closing, but the average is 1% to 3% of the total value.

Recording fees: It costs approximately $200 to record 1031 exchange. That amount can be higher if recording fees include transfer taxes. It can also be a flat fee or a percentage of the new loan when considered mortgage registration tax.

Loan fees for replacement property: Real estate professionals can acquire replacement property through a loan and pay origination fees and similar costs. Net proceeds of the loan can cover those charges to pay for notary, lender attorney costs, and document preparation.

Pro-rated taxes: Property sellers are responsible for pro-rated property tax payments. Proration is according to the days before closing. The amount can be up to 110% of the real estate taxes.

Closing costs likely to result in a taxable event

Other closing costs can lead to a taxable event. Examples include application fees, mortgage lender appraisals, property taxes, pro-rated rents, lender title insurance, maintenance and repair charges, lender’s title insurance, and many others. Consulting a tax advisor prior to the closing can help you get a reprieve through the tax-deferred exchange. You can also try other measures such as paying the amounts for such charges in a qualified escrow account with the sale closing agent. Security deposits, prorated property tax payments, and accrued interest can be non-recourse debt.

How are non-qualified exchange expenses treated? 

Non-qualified expenses are capital gains with a different tax basis. You can clear them before the closing to avoid paying more cash on tax liability. Even so, you can still spend some money out-of-pocket during purchase and sale contract closing, depending on the constructive receipt date.

Expect higher fees for non-standard 1031 exchanges

Non-standard exchanges like those involving multiple properties are more complicated. They differ from tax-deferred 1031 exchanges, making qualified intermediary’s use more crucial in such processes. Those factors increase the fees by exchange accommodators.

Is 1031 Exchange Fee Tax Deductible? 

Many 1031 exchange fees are tax-deductible. For instance, title closing fees and broker commissions eliminate tax liability.

When is a similar exchange worth the cost?

According to the tax court, a like-kind exchange may be worth the cost if the property owner has owned it for several years and has equity in its sale. A deduction on capital gains tax is typically much higher than costs to complete 1031 exchanges for taxable income. You can use the gain realized as a purchase price for another property.

Closing Point: Always ask for a full breakdown of costs before engaging in a 1031 Exchange, as costs can differ from one QI to another.

source https://www.transfs.com/1031-exchange-cost/

1031 Exchange Improvements

Through improvement exchange, investors can explore multiple improvement options for the properties currently in use. An investor can modify an existing property to achieve what they need. Some improvements are more straightforward, and others are complex. Either way, investors get to enjoy tax deferral and maximize investment opportunities throughout the improvement process.

WHAT IS AN IMPROVEMENT EXCHANGE 1031?

A 1031 exchange is a tool that investors can use within the Improvement Exchange to create tremendous investment opportunities and avoid paying capital gains taxes on the proceeds from the sale of the improved replacement property. However, full tax deferral is only possible when the investors acquire replacement property with a market value that is more than or the same as the property on sale. They must also invest the proceeds from the existing property in a new investment property.

WHAT IS A BUILD-TO-SUIT EXCHANGE?

With a build-to-suit exchange, the owner of relinquished property can use the sale earnings to get a replacement property and make the necessary improvements. That makes it easier for exchangers to capitalize on the investment opportunity by using 1031 exchange proceeds to construct or renovate the new property. If there is no other action, the surplus-value lost is tax-deductible in the context of an IRR.

Difference between a build-to-suit exchange and 1031 improvement exchange

Build-to-suit exchange applies when the new investment property is a piece of land for construction. On the other hand, 1031 improvement exchange is when there are existing structures that require refurbishing. Safe harbor provisions are available to ensure adherence to the procedures.

IMPROVEMENT EXCHANGE REQUIREMENTS

Below are the basic requirements for an exchanger to enjoy tax-deferred dollars when using the exchange.

The 1031 exchange requirements apply to the improvement exchange. The exchanger must use the exchange equity to complete improvements or make a down payment within 180 days. The improvement process must be complete before the exchanger can acquire the title of the new property. Meeting the like-kind requirement mandatory in improvement exchanges can be challenging within the 180-day exchange period. The exchanger receives real property when they give up one. That means if they receive unimproved property, full tax deferral will not be possible, even if the materials and labor force for improving the property are available. Those elements are in the services and personal property categories, meaning they are not like-kind to real property. An expandable company can finance the 1031 exchange if it receives non-improved land for future use.

The exchanger must identify replacement property within 45 days after the sale of the other one. That means disposing of the relinquished property, sending the earnings to a qualified intermediary, and coming up with a description of the new construction within that timeline.

The value of the replacement property must be greater or equal to the relinquished property with the completed improvements. That is known as the exchange value requirement or Napkin Test.

Do all improvements need to be made during the 180-day parking period?

If completing the improvements is not possible within the 180-day exchange period, the taxpayer gets credits for the value of land and improvements installed at the time of direct ownership. It will be up to the taxpayers to improve their services once this has happened.

LET’S EXPLORE THE 1031 IMPROVEMENT EXCHANGES PROCESS

 

Taxpayers gain more from an old property than a new one – the original purchase price is often lower than the final value of the replacement properties. That means the relinquished property value is usually higher than the replacement property value. If other factors do not interfere, the investors can reinvest the difference in property value and incur tax deductions under the 1031 exchange Internal Revenue Code. Improvements on the new property mean the exchanger can clear improvement costs before the completion process. They can use the built-to-suit exchange or property improvement exchange. That means developing a brand-new property on a piece of land or renovating an existing structure.

Investors must use a qualified intermediary (QI) in the improvement exchange format because the title to the replacement property must be in a third party’s name. The third party can also be an exchange accommodation titleholder (EAT) whose name appears on the purchase contract with as much detail as possible. In some cases, exchangers use contractors to get land for new construction.

Only the title to the replacement can go to the EAT or QI. The exchange funds go to an exchange account that the taxpayer or exchanger creates. The exchange accommodation titleholder will pay for the improvement expenses from the escrow account with the guidance of the investor.

The qualified exchange accommodates agreement allows the representative to hold the title for the 180-day exchange period or until the completion of the new construction. Improvement exchanges requirements for new property constructions tend to be more stringent. For instance, once QI or EAT takes title, they can only give it back when construction is complete within 180 days. The entire exchange equity must also go towards the building costs within the stipulated duration.

Sometimes the taxpayer takes a construction loan to finish the improvements. The purchase agreement allows the representative to remain responsible for the loan funds until the transfer of replacement property to the taxpayer.

BENEFITS OF THE 1031 IMPROVEMENT EXCHANGE

An exchanger can renovate, construct from the ground up, and add capital improvements while enjoying tax deferral, making it a better investment.

The 1031 exchange offers several advantages which can lead to tremendous investment opportunities, such as more valuable properties than properties readily available on the open market.

In addition, the ability to remodel and improve the infrastructure can help provide tax-deferred investments that are more lucrative. Other options are available under the new version of these regulations, and since 1993, Treasury Regulations and the Rev. Proc. 2000 – 35 established the standards of improving the production of the product. Improvement exchanges continue.

One of the other advantages of a new property is that the same property must not require complete replacement within 180 days.

The biggest drawback of the improvement exchange

Building from the ground up within the 180-day exchange period is not easy. Build to suit exchange costs can also be higher than other tax-deferred exchanges. Transfer taxes, closing charges, and escrow fees add to the total exchange funds.

REVERSE IMPROVEMENT EXCHANGE

Improvement exchange can be delayed improvement exchange or reverse improvement exchange. Delayed improvement is the most popular. It involves the disposition of the relinquished property and sending the 1031 exchange proceeds to the QI.

Reverse exchange is an improvement exchange format where the EAT acquires the replacement property after getting funds from the taxpayer or lender.

Difference between forward and reverse build-to-suit or improvement exchanges

Building/improvement swapping is a twofold process. A taxpayer can sell the property before the purchase date and fund a new 1031 exchange account. The exchange funds can go to the EAT in exchange for a share in new investment. The remaining amount of money becomes available to EAT as needed to pay for costs related to the work. That is forward construction/sales exchange.

Reverse build-to-suit applies when the exchanger wants to add capital improvement before completing the sale of the original property.

WHEN TO USE 1031 IMPROVEMENT EXCHANGE

1031 improvement exchange is commonly utilized when the replacement property does not have equal or greater value to the relinquished property. The 1031 exchange removes the taxable situation by adding capital improvements.

1031 also applies when an exchanger does not want properties in the open market or if a taxpayer prefers to use tax-deferred dollars to refurbish a new investment property with equal or greater value.

FLEXIBLE PROVISIONS IN THE REVENUE PROCEDURE 2000-37

The revenue procedure provides the following:

·       The exchanger can be the contractor during the improvements

·       EAT can lease the acquisition to the taxpayer within the parking period

·       The exchanger can guarantee construction loans that EAT gets or loan them directly

·       A taxpayer can compensate EAT for expenses

How does the use of an EAT help in an exchange involving improvements?

EAT can retain ownership of the title and park the new property for the taxpayer while the improvement exchanges continue for 180 days. After ownership transfer, the taxpayer gets the improved property with the additional value achieved during parking. EAT uses a limited liability company to isolate exchange transactions.

source https://www.transfs.com/1031-exchange-improvements/

1031 Exchange Ownership Rules

The meaning of section 1031

1031 exchange is a common term among real estate agents and other investors.

Section 1031 is part of Internal Revenue Service regulations that hold the requirements for people interested in swapping investment property. Most exchanges of like-kind nature are taxable, but section 1031 allows tax deferral at the exchange period. Through the internal revenue code, real estate investors can avoid paying taxes on the capital gain when they buy real property using the proceeds from the sale of the first one. Section 1031, also 1031 exchange, imposes time limits for the exchanges and mandates that the replacements properties have equal or greater value. There are several rules and guidelines which you must follow in order not to get taxed by the IRS or have other complications during your time frame of use!

We take a look at some of these rules in this article

What Are Some Of The 1031 Exchange Ownership Rules You Need To Know About?

The Same Taxpayer Rule in 1031 Exchanges

The same taxpayer rule is fundamental in every 1031 exchange, especially if you want to enjoy tax deferral treatment. The person who sells the relinquished property must purchase a replacement property. Taxpayers can be individuals, LLCs, corporations, or any other entity. Either way, the title of the new property must be the same as the other property.

Although the same taxpayer rule may seem simple, most investors fail to recognize and implement it. Several factors such as loan requirements, liabilities, and other business aspects may make the same vesting challenging. Regardless, failure to maintain the tax identity hinders the continuity of tax.

Exceptions to the taxpayer rule exist. They apply to investors with disregarded entities for tax purposes.

How is a 1031 exchange structured?

Every 1031 exchange process requires the involvement of accommodators who agree to a property holding arrangement with the taxpayer. They keep the exchange proceeds and taxpayer rights in the exchange.

The accommodator holds the funds in an escrow account to acquire the replacement property. The funds can also pay for closing costs, mortgage loans, or a deed of trust for the one property. However, the money cannot cover debts that are not present in the mortgage of the relinquished property. If it is a build-to-suit-exchange, the funds can aid in capital improvements or the development of vacant land.

The same taxpayer requirement in a 1031 exchange allows separate taxpayer investment. However, that is usually challenging because of the like-kind replacement property requirement. Finding someone else with a property exactly like the one you are selling can be impossible. Such a move can lead to delayed exchange, but you still have to honor the rules of timing.

180-day rule

Investors must acquire replacement property within 180 days after selling the old one using the delayed exchange.

45-day rule

The investor must identify replacement property and inform the qualified intermediary about it in writing within 45 days after the relinquished property sale. The internal revenue code allows the designation of multiple replacement properties identified so long as you pay the entire purchase price of one of them and they meet the valuation requirements.

It is important to note that the two rules run simultaneously. The earlier you designate a property, the sooner you can close on it.

What is a reverse exchange?

Reverse exchange differs from the delayed exchange by allowing the purchase of a new property before the sale of the old one without mandating investors to pay taxes. The timing rules apply, meaning the taxpayer must give up the new property to an intermediary within 45 days and finish the replacement process within 180 days.

The same taxpayer rule and spouses

The same taxpayer requirement mandates that the spouse whose name appears on the title of the relinquished property should be on the replacement property. Your legal advisor might advise you to complete the exchange and wait a few years before adding the other name.

Death of a Taxpayer during a 1031 Exchange 

If a taxpayer passes on before completing the exchange process after selling the first property, the deceased estate can complete the process. The estate gets 1031 tax-deferred exchange benefits if there is continuity.

1031s for vacation homes

1031 tax-deferred exchange can also be profitable for taxpayers who own retirement or vacation homes. The process is slightly different. You can avoid capital gains taxes if you start renting out the property – not if you convert it into a primary residence.

There are business considerations to take into account – it only becomes a business property if you professionally conduct yourself with the tenant. The internal revenue code can only recognize the investment real estate property as viable for 1031 exchange if it has tenants.

Moving into a 1031 Swap Residence

The internal revenue service has a safe harbor rule for taxpayers who want to turn a replacement property into a primary residence. The code requires that the taxpayer rents out the personal property for at least two weeks for fair rental. If you keep the property obtained for personal use, you cannot do so for more than 14 days or ten percent of the total duration the property is up for fair rental within 12 months.

Remember, you cannot change the new property into a primary residence to capitalize on the $500,000 exclusion.

1031s for estate planning

Tax deferral treatment in a 1031 exchange is not infinite. Tax liabilities can catch up with investors after some time. However, such responsibilities only remain viable until death. If a taxpayer passes on before selling any property acquired through 1031 exchange, those who inherit the real estate will not incur taxes. They take ownership of the property with the new market value, making 1031 exchanges perfect for estate planning.

Can you do a 1031 exchange on a primary residence?

Real estate properties like primary residence do not meet the exchange treatment requirements. A property that a taxpayer lives in does not count as an investment property unless you rent it out for a significant period. The investor must relocate elsewhere to make the property eligible.

Can you do a 1031 exchange on a second home?

A second home or vacation property has different tax purposes from properties allowed in a 1031 exchange. It can only qualify for the exchange treatment if it provides income as a business property.

How do I change ownership of replacement property after a 1031 exchange? 

Buying an exchange property to change the title to the replacement to someone else after completing the process is not advisable for tax purposes. Do not give the replacement property to someone else soon after purchase. The Internal Revenue Service considers such a move non-eligible for 1031 exchange by assuming you did not get it for investment.

Can a taxpayer exchange with another party?

The internal revenue code allows the exchange of property with another party, but they must hold it for at least two years. An attempt to structure the 1031 exchange in a way that avoids that duration can lead to disqualification.

Taxpayers cannot exchange partnership interests or gain a partnership interest unless they use single-member LLC. IRS treats such LLCs as if the real estate belongs to a sole member. The regulations differ for multi-member LLCs. Any partnership that owns real estate and wants to exchange it must not involve the partners – only the LLC. If some partners prefer the exchange and others do not:

• They can acquire multiple replacement properties and discontinue the association. They can then disburse the properties to redeem the other opposers’ interests.
• They can dissolve the partnership before starting the exchange process.
• They can spend less than the exchange value, allocate the gain to the uninterested partners, and liquidate the cash to liquidate partnership interest.

Special Rules for Depreciable Property

A property can wear and tear during its lifespan, and investors can pay lower property taxes by factoring in the costs of such depreciation. The depreciation value is the portion of the investment property cost that the IRS writes off annually. The internal revenue service can recapture those deductions when you sell the property at a fair market value. Engaging in a 1031 exchange can help avoid the accumulated depreciation amount in the taxable income.

What are the tax consequences of an exchange?

Any leftover cash after the intermediaries acquire replacement property is known as boot. The amount is taxable. According to the tax code, it is taxable even if the accommodator sends that money to the taxpayer after 180 days. Such proceeds can come from a direct profit from the sale of loans associated with the property. For instance, if the mortgage on the second property is less than that of the relinquished property, the difference automatically becomes a boot. The Internal Revenue Service considers that amount as income to the taxpayer.

Vesting issues in 1031 exchanges – disregarded entities

Exceptions to the 1031 tax code rule only apply for a disregarded entity. Exchangers who cannot meet the same taxpayer requirement can avoid the implications of the general 1031 exchange rule through the disregarded regulation. Examples of disregarded entities include Delaware statutory trust, revocable living trust, and Illinois land trust.

Changes to 1031 Rules

The internal revenue code allows the following vesting changes in an exchange.

The investor estate can take over an incomplete exchange if the exchanger dies after selling the relinquished property. That must be before getting the replacement property.

The revocable living trust of the exchanger or grantor can acquire the property using the name individually. The rule only applies when the taxpayer’s investment is a disregarded entity.

Taxpayers can acquire property using a single-member LLC after selling the relinquished property. An exchanger can also acquire multiple replacement properties using several single-member LLCs as long as they are a sole member. The LLCs must be disregarded entities.

The taxpayer rule also allows a husband and wife to use 1031 exchange if the property they want to give up belongs to one person. The individual relinquished property is treated as community property, and the title to the replacement property goes to a two-member LLC. The community property qualifies for tax deferment in community property states. The couple must treat the LLC as a disregarded entity.

A business entity can merge out in tax-free reorganization after selling relinquished property and acquire the replacement property as a new business entity.

Adding a spouse who was not on a relinquished property title to a replacement property can lead to partial recognition of capital gain. Divesting relinquished property that a single entity like a business entity or multiparty LLC holds can disqualify the 1031 exchange benefits. The Internal revenue service recognizes the differences in taxpayers who start the exchange and those who complete it, nullifying the tax advantages. However, changing a general partnership to an LLC before the stipulated exchange duration elapses can qualify under the same taxpayer rule.

Can husband and wife do a 1031 exchange?

A tax advisor can give insight for couples who file joint tax returns, do not share the title of the relinquished property, but want part of the title to the replacement property. Such incidences remain an open issue; therefore, the safest approach is to leave the vesting as is during the exchange period or after. The tax identity on the relinquished property should be on the replacement property.

If only one owns the relinquished real estate, buying the replacement property as a partner does not meet the same taxpayer rule. Other scenarios that may not meet the same taxpayer requirement include:

• When a lender wants both spouses on the title of a replacement property, and only one has the relinquished property.
• When both spouses are on the title of the real property and a lender wants only one spouse on the replacement property title.

Confirm the exchange structure with your tax advisor before relinquishing the property to avoid the taxable problem.

How are mortgages on relinquished property treated?

Proceeds from the 1031 exchange transaction can pay off relinquished property mortgage. The amount that pays off the mortgage as realized proceeds is a portion of the exchange value. Investors should replace it with another mortgage or cash payment because exchange funds can only repay loans for purchasing relinquished properties if the property has a deed of trust.

The same taxpayer rule in a 1031 exchange does not recognize foreign properties. It is essential to consult a tax advisor before engaging in any exchange transaction.

 

source https://www.transfs.com/1031-exchange-ownership-rules/

What Are The Options For Gold Investing During Covid 19

Is Gold Worth Investing In During COVID 19?

Gold bars and stok market

Due to COVID 19 or coronavirus, financial markets have plummeted and unemployment has skyrocketed. These events have made everybody anxious with investors desperately searching for safe places to place funds.

You might have considered investing in fixed income (i.e bonds), but these can be subject to interest rate and inflation risk. It could be wise to look at investments that aren’t susceptible to inflation, like precious metals since the government is increasing spending. Below, you’ll learn about the top reasons to invest in Gold during the COVID 19 pandemic.

Inflation and Deflation Hedge

Gold is a tangible metal that has a finite supply, unlike dollars that can be endlessly printed by the Federal Reserve. Currently, the government has lowered interest rates, offered special business relief packages, and “free” stimulus checks to help those struggling due to the COVID 19 pandemic. However, these actions will greatly increase the inflow of dollars, which leads to higher inflation.

Increased inflation will raise the prices of everyday goods and services, as this will strain the already burdened middle class. Having gold exposure will protect your portfolio as gold prices tend to rise during periods of high inflation. Gold prices have also skyrocketed around times of uncertainty like the 2008 economic crash. Per the chart below, the price per ounce rose above $1,000 during 2008 and hit 2,000 in 2012. It’s continued to increase during this crisis as well and is currently trading around $1,700 per ounce.

What happens to the demand for gold during deflation, which is the opposite of inflation? During deflation, prices decline and economies around the world are burdened with debt. It also makes people distrust and loses confidence in their local government. Deflation was experienced during the Great Depression and in some areas after the 2008 financial crisis. People chose to hoard cash, with gold bars and gold coins being the safest places to do this.

COVID 19 Impact on Gold Mines

COVID 19 has been extremely unique as it has closed down schools, parks, beaches, and other non-essential businesses, including mines. Since mines are closed, it has become much harder to create gold bars and coins. Many investors are accustomed to investing in these assets, which are becoming more scarce and expensive due to closed mines. Many gold companies are requiring investors to pay premiums in addition to the regular coin or bar price as well.

Gold ETFs

Luckily, you can obtain gold exposure by investing in Gold ETFs. The two main types of Gold ETFs are:

1. Those that track the price change of the metal. These investment pools either store physical gold bullion and/or have sizable gold futures contracts.
2. Investment pools that invest in gold-related companies. Some of the underlying companies can include those that mine gold directly or provide financing to gold miners. Gold financing firms often have contracts that let them directly buy gold from the mining company at a discounted rate.

There are many gold ETFs to select from like the SPDR Gold Trust, IShares Gold Trust, and Van Eck Merk Gold Trust. Axel Merk, the founder of the VanEck Merk Gold Trust (OUNZ) ETF, stated “I think gold is going to go higher,” “Historically, in times of crisis people like to have gold.”

With uncertain times, inflation around the corner, and mining companies closing, he may be right.

Versatility

Unlike paper assets such as stocks, gold is very versatile. For example, it can be used to create jewelry, metals, and statues. Besides this, it’s very valuable in medicine and dentistry as well. Dentists use gold to fill cavities, crowns and create other orthodontic appliances because it’s very malleable.

Gold also doesn’t react with other metals and won’t cause chemical reactions. It’s also very safe because it’s nonallergic, so patients won’t have to worry about any negative side effects. These traits make it a perfect resource for creating various shaped tools and fillings.

Gold has been used in dentistry since 700 B.C when pre-Roman civilizations used gold wire to repair their patients’ teeth. It was also used to fill cavities during ancient times, but its usage slightly declined during the 1970s when prices increased. Despite price increases, dentists and other medical professionals are continuously using gold for various procedures.

It’s a very valuable tool for the semiconductor industry as it carries electrical charges easily. Gold can be found in chips, computers, cell phones, and other electronics. Unlike silver, it’s not susceptible to corrosion or oxidations, which can damage entire systems.

Another little-known use for gold is in aerospace, especially on satellites. Satellites float in space and it can be hard to repair these tools. So, it’s crucial to ensure that these along with other space devices are built with the highest quality materials. Gold also acts as a lubricant between mechanical parts. Organic lubricants would be broken down by the intense radiation of the Earth’s atmosphere, but Gold can withstand this.

Correlation to other investments

Diversification is key to having a stable financial portfolio as it prevents you from being overweight in one asset class. You might think that having a mix of stocks, bonds, and ETFs is sufficient. However, all of these assets can be negatively impacted by inflation, interest rate risk, credit risk, and other unseen perils.

Gold can be a great portfolio hedge as it performs well when stocks decline. This was seen as recently as 2019 when investors were fearful of heightened market volatility. Gold can be a great portfolio hedge, but it’s crucial to not invest your entire portfolio into this asset class. A good rule of thumb is to invest up to 10% of your portfolio into gold. This can include investing in a combination of physical gold and gold ETFs or even through a gold IRA. If you have never thought about that before, you can check out our frequently asked questions concerning gold IRA investment.

 

Bottom Line

These are scary, uncertain times with rising unemployment and volatile markets. Despite this, there is an opportunity to thrive, and investing in tangible resources like gold can add some stability to your portfolio. It’s prudent to consider investments that won’t be significantly impacted by high inflation, interest rate risk, or credit risk. Investors think bonds are “safe” but they can be just as risky as equities if they have mediocre credit ratings.

source https://www.transfs.com/what-are-the-options-for-gold-investing-during-covid-19/