1031 Exchange Programs

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1 Can You Invest in Real Estate and Enjoy Leisure Time? With your wise decision to own real estate, you re already far ahead of the average investor. But management intensive properties and dwindling returns have many investors singing the blues. Tenants, toilets, and trash are the bane of many property owners. Daily headaches, lack of time, freedom, and lower monthly cash flows might tempt you to sell. But simply selling isn t your only option. Keeping real estate in your investment portfolio is important to you, and selling a highly appreciated asset could result in significant capital gains taxes. So, what can you do? Section 1031 of the Internal Revenue code provides an effective strategy for deferring the capital gains tax that may arise from your business/investment property sale. Securities and Advisory Services offered through Centaurus Financial, Inc., Member FINRA SIPC, A Registered Investment Advisor. Centaurus Financial, Inc. and H&S Wealth Management are unaffiliated firms. This is a brief and general description of 1031 exchanges, and is not meant to include all relevant provisions of a 1031 exchange. Prospective investors should consult with their own tax advisors regarding a 1031 exchange. Section 1031 of the Internal Revenue code provides an effective strategy for deferring the capital gains tax that may arise from your business/investment property sale. By exchanging one rental or business property and reinvesting the net proceeds into other like-kind real estate, you can defer the recognition of capital gains taxes and depreciation recapture, which could potentially leave you with substantially more proceeds to purchase a replacement property. Internal Revenue Code 1031 Exchanges are one of the most powerful tax deferral strategies available. Don t assume, however, that you are stuck with replacing one sole-ownership, self-managed property and its associated problems for another. An exchange into a co-owned or Delaware Statutory Trust (DST) institutional-quality property provides professional property asset management with the potential to generate steady income, tax benefits, and appreciation. With a DST 1031 Exchange, you no longer have to feel burdened by your real estate. You may enjoy the benefits of income property ownership AND savor more time and freedom. H&S Wealth Management TF: (866) Fax: (310) HandSwealth.com Supervisory Branch: Centaurus Financial, Inc E. Katella Ave., Suite 200, Anaheim, CA TF: (800)

2 H&S Wealth Management specializes in 1031 Exchange Delaware Statutory Trust replacement properties designed to meet wide-ranging needs from small investors with limited funds to those wishing to invest significant capital. The Delaware Statutory Trust structure allows investors to own and participate in the potential profitability of large institutional-quality real estate while delegating the hassles of property management to the professionals. The Delaware Statutory Trust (DST) Investors may benefit from the turnkey approach and pre-packaged nature of DSTs. You are able to simplify your life through the elimination of time-consuming and sometimes costly management problems. A Delaware Statutory Trust (DST) is a type of co-ownership or fractional ownership structure, where owners obtain a beneficial ownership interest of a trust that owns real estate. This is different from a Tenant-In-Common (TIC) in which the owners own an undivided fractional interest in the entire property. Some of the TIC properties that struggled in the economic downturn of 2008 were burdened by an unwieldy governance structure, and the DST has improved on the model for co-ownership with more efficient decision making procedures. Both DSTs and TICs allow you to pool your money together with others to invest in larger, institutional-quality properties such as multifamily residential, office, retail, industrial, hospitality, assisted living, golf courses, self-storage, and even oil and gas producing wells that you probably could not afford on your own. As a TIC co-owner you would have received a separate deed and title for your pro-rata share of the property, while as a DST coowner you will receive a beneficial ownership interest in the Trust. You will share in your percentage interest of the property s costs, economic, and tax benefits. Cash flows are typically paid monthly and are partially tax-advantaged via depreciation pass through and interest deductions. You will retain rights similar to a soleownership property (with some limitations). National real estate companies, referred to as sponsors, structure the DST offerings. The sponsor s duties include the identification, selection, acquisition, financing, and management of the property. They are also responsible for handling the property s future sale. Investors may benefit from the turnkey approach and prepackaged nature of DSTs. You are able to simplify your life through the elimination of time-consuming and sometimes costly management problems. 2 DSTs keep investor capital working with goals such as increasing monthly cash flow and providing capital appreciation, and

3 by exchanging into a DST, you may defer any capital gains and depreciation recapture taxes. (There s no guarantee that a particular DST will be able to achieve all of these goals.) What Is The Minimum Investment? Minimum investments are typically in the $100,000 range, with the average investment around $250,000. The low minimums allow many to invest in various DST properties, diversifying their portfolios through different asset classes and geographic locations. What About 1031 Exchange Investors? DSTs are popular choices for 1031 Exchange investors. Having access to the leading 1031 Exchange sponsors gives you a large property inventory from which to choose. You can select from various asset classes and geographic regions and look for properties that meet the strict IRS imposed deadlines for the identification and closing on your replacement property(s). Since DSTs come pre-packaged, they can eliminate many real estate transaction worries. In August of 2004, the Internal Revenue Service issued Revenue Ruling detailing how a Delaware Statutory Trust will be classified for federal tax purposes and whether a taxpayer may acquire an interest in the DST under Internal Revenue Code Section 1031 (1031 Exchange). Revenue Ruling provides guidelines allowing you to exchange your investment property into a Delaware Statutory Trust. DSTs are popular choices for 1031 Exchange investors. Having access to the leading 1031 Exchange sponsors gives you a large property inventory from which to choose. At tax time, you simply report your DST investment property on Schedule E, the same as you did with your sole-ownership or TIC property. Some DST Advantages: $ $ Turnkey pre-packaged real estate solutions $ $ More time and freedom by eliminating mundane management obligations $ $ Potential for regular cash flow with less liability (non-recourse debt) 1 $ $ Greater diversification in your real estate portfolio $ $ Economies of scale 1 The actual amount and timing of distributions is not guaranteed and may vary. There s no guarantee investors will receive distributions or a return of their capital. 3

4 Some DST 1031 Exchange Advantages: $ $ Inventory of property choices to meet your 1031 deadlines $ $ Use leverage to increase appreciation potential $ $ Ability to exchange even or up to eliminate boot $ $ Ability to identify back-up properties for timely closing $ $ Investment can be diversified into more than one property Some H&S Wealth Management DST Advantages: $ $ Access to the nation s leading 1031 Exchange sponsors $ $ Your needs are put first in every offering $ $ We adhere to the highest levels of professional ethics $ $ We provide continuous service and support before, during, and after you invest Some DST Risks: There are many risks associated with DST programs. Potential investors should review these risks in their entirety in the Private Placement Memorandum prior to considering an investment in a DST offering. The list of risks below is not meant to be exhaustive, but includes some of the risks most commonly associated with a DST investment. DST interests are not suitable for everyone. Prospective investors must be accredited, must be prepared to bear the economic risk of an investment in the DST interests for an indefinite period of time and, must be able to withstand the total loss of the invesment. DST interests are subject to the usual risks of real estate, including, among others, local conditions such as an oversupply of space or reduced demand for properties, an inability to collect rent, vacancies, inflation and other increases in operating costs, adverse changes in laws and regulations applicable to owners of real estate and changing market demographics. DST interest cash flows and returns are not guaranteed. DST interests involve fees that may offset tax savings. 4

5 DST interests are generally illiquid with a limited to no secondary market. DST interests require a high level of due diligence. DST interests involve a certain loss of control since final decisions on action items fall to the trust manager. Material tax risks, including treatment of the DST interests for purposes of section 1031 and the use of exchange funds to pay acquisition costs, which may result in a taxable boot. Risks related to the terms of the financing for the property, including the lack of a loan commitment and the use of leverage, which presents an additional element of risk in the event that the cash receipts from the operation of the property are insufficient to meet the principal and interest payments on such indebtedness. What Is a 1031 Exchange? Section 1031 of the Internal Revenue Code allows a taxpayer to sell one business or investment property and exchange it for a likekind business or investment property in order to defer the capital gains tax that may arise from the property sale. The tax code states: No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. A well-executed exchange results in the taxpayer being able to utilize 100% of the proceeds from the sale of his/her property to purchase a replacement property, thereby deferring all capital gains state and Federal taxes. Section 1031 does not apply to exchanges of inventory, stocks, bonds, notes, or other securities. A well-executed exchange results in the taxpayer being able to utilize 100% of the proceeds from the sale of his/her property to purchase a replacement property, thereby deferring all capital gains state and Federal taxes. If, as part of the exchange, the taxpayer receives other (not like-kind) property or money called boot taxable gain is recognized to the extent of the other property and money received. 5

6 Basic rules for a 1031 Exchange: Note that IRS regulations require the use of a Qualified Intermediary to properly complete an exchange. This is a brief and general description of 1031 exchanges, and is not meant to include all relevant provisions of a 1031 exchange. Prospective investors should consult with their own tax advisors regarding a 1031 exchange. 1. Receive only like-kind replacement property. 2. Use all proceeds from the relinquished property for purchasing the replacement property. 3. Make sure the debt on the replacement property is equal to or greater than the debt on the relinquished property. (Note that a reduction in debt can be offset with additional cash, however, a reduction in equity cannot be offset by increasing debt). 4. Take title to the new property under the same name as title was held to the relinquished property. How does it work? 1031 Exchanges are typically executed as delayed exchanges, also referred to as Starker Exchanges. There are four players and four basic steps in an exchange. Who are the players? 1. Exchanger the party initiating the exchange who benefits from the deferral of capital gains taxes on the relinquished property. 2. Buyer the party acquiring the exchanger s relinquished property. 3. Seller the party selling the replacement property to the exchanger. 4. Qualified Intermediary (Accommodator or Facilitator) the neutral third-party that takes possession of the exchanger s sales proceeds, uses the funds to purchase the exchanger s replacement property, then transfers title of the property to the exchanger. Note that IRS regulations require the use of a Qualified Intermediary to properly complete an exchange. You may not use your current CPA or attorney, or anyone related to you, or with whom you have had a financial relationship within the two years prior to the close of escrow. What are the steps? 6 1. Exchanger arranges for the sale of investment property and includes exchange language in the contract. 2. At closing, the sale proceeds go to a Qualified Intermediary for a 1031 Exchange.

7 3. Exchanger identifies up to three (3) potential exchange properties within 45 days of closing. 4. Exchanger completes the 1031 Exchange (closes escrow) on one of the properties identified in Step 3 within 180 days of closing. We recommend that you sell your property before you purchase a replacement property. On occasion, an exchanger will find the ideal replacement property before a buyer is found for the relinquished property. If this situation occurs, a reverse exchange buying before selling may be necessary. No clear IRS guidelines exist for reverse exchanges. It s important that you do not dissolve partnerships or change the manner of holding title during the exchange. A change in the exchanger s legal relationship with the property could jeopardize the exchange. The beauty of a 1031 Exchange into a Delaware Statutory Trust property is the turnkey approach. Exchange deadlines It is often difficult to complete a 1031 Exchange within the strict IRS deadlines. You have a short window of 45 days at the close of escrow on your sold property in which to identify up to three suitable replacement properties with the right value, equity, debt ratios, and closing schedule. The exchange must be completed within 180 days from the closing date of your sold property to close on the purchase of your new property(s) that you have identified in your 45-day list. Failure to follow these deadlines will disqualify the entire exchange. The beauty of a 1031 Exchange into a Delaware Statutory Trust property is the turnkey approach. Sponsors provide the identification, acquisition, financing, and closing, eliminating many of your worries. And don t forget that DSTs alleviate management hassles, have the potential for higher net cash flow and property appreciation, and provide tax benefits. What if I die? During your lifetime you may execute a series of 1031 Exchanges from one property to another as a means of tax deferral. Should you die while owning your investment property, under current tax rules, your heirs will receive a stepped up basis to fair market value and the capital gain may not be taxed. 7

8 How do I get started? It s preferable to plan ahead for your 1031 Exchange. We recommend consulting with your attorney, tax accountant, financial planner, and Qualified Intermediary (QI) in advance. We ll be happy to provide you with a list of QIs in your area. If you re interested in exchanging into a DST, contact us as soon as possible so that we may provide you the information you need to choose wisely. If you re interested in exchanging into a DST, contact us as soon as possible so that we may provide you the information you need to choose wisely. Securities and Advisory Services offered through Centaurus Financial, Inc., Member FINRA SIPC, A Registered Investment Advisor. Centaurus Financial, Inc. and H&S Wealth Management are unaffiliated firms. This is neither an offer to sell nor solicitation of an offer to buy any securities. Offering facts and terms are controlled by a sponsor s final Private Placement Memorandum (or prospectus). All investments and tax strategies have risks, including the possible loss of principal in many cases. Always review the offering document for a more thorough discussion of risks, expenses, and limitations. Past performance and/or forward statements are never an assurance of future results. Centaurus Financial, H&S Wealth Management, and its representatives and assigns do not give tax, legal or accounting advice; nothing herein should be construed as such. Glossary Like-Kind Property Like-Kind refers to the type of property being exchanged. You can exchange any real estate investment for any other type of real estate held for investment purposes for example, vacant land can be exchanged for rental property. In most cases your personal residence is not Like-Kind investment property. Exchanging Up To accomplish a fully tax-deferred exchange, the rule of thumb is to exchange even or up in value: exchange even or up in equity and in debt. Boot To the extent that you do not exchange even or up in value and/or exchange even or up in equity and debt, you will have received nonqualifying property boot in your exchange. If boot is received, tax is computed on the amount of gain on the sale or the amount of boot received whichever is lower. Our goal is to keep our clients financially phi 2 t: 8

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