Investors section
1031 tax exchanges
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1031 exchange. (Discuss)
Under Section 1031 of the Internal Revenue Code (26 U.S.C. § 1031),
the exchange of certain types of property may defer the recognition
of capital gains or losses due upon sale, and hence defer any capital
gains taxes otherwise due.
To qualify for Section 1031 of the Internal Revenue Code, the properties
exchanged must be held for productive use in a trade or business
or for investment. Stocks, bonds, and other properties are listed
as expressly excluded by Section 1031 of the Internal Revenue Code.
The properties exchanged must be "like-kind", i.e. of
the same nature or character, even if they differ in grade or quality.
Personal properties of a like class are like-kind properties. Personal
property used predominantly in the United States and personal property
used predominantly elsewhere are not like-kind properties.
Real properties generally are of like-kind, regardless of whether
the properties are improved or unimproved. However, real property
in the United States and real property outside the United States
are not like-kind properties.
Taxpayers may wonder whether items such as equipment used on a
property are included in the lump-sum sale of the property, and
if they are able to be deferred. Under treasury regulation §1.1031(k)-1(c)(5)(i),
property that is transferred together with the larger item of value
will not exceed 15% of the fair market value of the larger property.
So for equipment with a fair market value of $15,000, as long as
the qualified like-kind property sells for >$100,000, the equipment
can be included in the exchange of property and any gain realized
can be deferred.
Cash to equalize a transaction cannot be deferred under Code Section
1031 because it is not like-kind. This cash is called "boot" and
is taxed at a normal capital gains rate.
If liabilities assumed by the buyer exceed those of the seller
(taxpayer), the realized gain of the seller will be not only realized,
but recognized as well. If however, the seller assumes a greater
liability than the buyer the realized loss cannot offset any realized
and recognized gain of receiving boot such as cash or other personal
property considered boot.
Originally, 1031 cases needed to be simultaneous transfers of ownership.
But since Starker vs. U.S. (602 F.2d 1341), a contract to exchange
properties in the future is practically the same as a simultaneous
transfer. It is under this case that the rules for election of
a delayed 1031 originated. To elect the 1031 recognition, a taxpayer
must identify the property for exchange before closing, identify
the replace property within 45 days of closing, and acquire the
replacement property within 180 days of closing. A Qualified Intermediary
must also be used to facilitate the transaction.
Section 1031 Like-Kind Exchanges
Section 1031(a) of the Internal Revenue Code (26 U.S.C. § 1031)
states the recognition rules for realized gains (or losses) that
arise as a result of an exchange of like-kind property held for
productive use in trade or business or for investment. It states
that none of the realized gain or loss will be recognized. It also
states that losses cannot be deducted.
1031(b) states when like-kind property and boot can be received.
The gain is recognized to the extent of boot received.
1031(c) covers cases similar to those in 1031(b) except when the
transaction results in a loss. The loss is not recognized at the
time of the transaction, but must be carried forward in the form
of a higher basis on the property received.
1031(d) defines the basis calculation for property acquired during
a like-kind exchange. It states that the basis of the new property
is the same as the basis of the property given up, minus any money
received by the taxpayer, plus any gain (or minus any loss) recognized
on the transaction. If the transaction falls under 1031(b) or (c),
the basis shall be allocated between the properties received (other
than money) and for purposes of allocation, there shall be assigned
to such other property an amount equivalent to its Fair Market
Value at the date of the exchange.
1031(e) stipulates that livestock of different sexes do not qualify
for like kind exchange.
1031(h)(1) stipulates that real property outside the United States
and real property located in the United States are not of like
kind.
Real Estate Investment Analysis Formulas
Income and Expense Statement
Income
Potential Gross Income (PG1) $__________
Less: Vacancy and Bad Debt Allowance __________
Equals: Effective Gross Income (EGI) $__________
Operating Expenses
Exclude: Depreciation
Mortgage Payments
Non-Operating Expenses. E.G Directors Salaries
Capital Expenditures $__________
Net Operating Income (NO1) __________
Less: Debt Service (P + I) __________
Cash Flow Before Tax (CFBT) __________
Less: Income Taxes __________
Equals Cash Flow After Tax (CFAT) $__________
Financial Measures:
Potential Gross Income Multiplier (PGIM)
Also called Potential Gross Rent Multiplier(PGRM)
PGIM = Market Value or Market Value = Potential Gross Income x PGIM
Potential Gross Income
MV = EGI x EGIM
= MV
PGI
Effective gross Income Multiplier (EGIM)
Also called Effective Gross Rent Multiplier(EGRM)
EGIM = Market Value or Market Value = Effective Gross Income x EGIM
Effective Gross Income
MV = EGI x EGIM
= MV
PGI
Net Income Multiplier (NIM)
NIM = Market Value or Market Value = Net Operating Income x Net Income Multiplier
Net Operating Income
MV = NOI x NIM
= MV
NOI
Capitalization Rate (Cap Rate)
Also called Broker’s Yield
Cap Rate(%) = Net Operating Income x 100 or Market Value = Operating Income x 100
Market Value Cap Rate(%)
= NOI x 100 MV = NOI x 100
MV Cap Rate(%)
Return on Equit y(ROE)
Also called: Equity Dividend Rate(EDR)
Cash on Cash Return
ROE(%) = (Net Operating Income – Debt Service) x 100
Equity
Where: Equity = Market Value – Mortgage
Debt Service = Principal & Interest Payment or MV = (NOI-DS) x 100 + Mortgage
ROE(%)
ROE(%) = Cash Flow Before Tax x 100
Equity
ROE(%) = (NOI–DS) x 100
(MV–Mtge.)
Default Ratio (Break-even) (%)
Using Potential Gross Income Using Effective Gross Income
= (Operating Expenses + Debt Service) x 100 = (Operating Expenses + Debt Service) x 100
Potential Gross Income Effective Gross Income
Financing Measures.
Debt Service Ratio (DSR) Loan to Value Ratio (%)
= Net Operating Income = Loan Amount x 100
Debt Service Market Value
Rental Apartment Building Measures.
1. Price Per Suite
2. Price Per Sq. Foot (Using Suite Areas)
3. Rents Per Sq. Foot per month
4. Operating Costs
a. Operating Costs Per Suite Per Year
b. Operating Cost per Sq. Foot per Year
5. Operating Expense Ratio (OER) = Operating Expense x 100
Effective Gross Income
Home Financing:
Gross Debt Service Ratio = (Principal + Interest + Taxes)
Gross Family Income
Lenders often modify the basic Gross Debt Service Ratio Formula.
Modified Gross Debt Service Ratio = (Principal + Interest + Taxes + Heat + % of Maintenance
Gross Family Income
Total Gross Debt Service Ratio = (Principal + Interest + Taxes + Other Debt Payments)
Gross Family Income
Commercial Real Estate Sample Calculations
The following examples illustrate how to use the real estate formulas. In Example No.1 the information is obtained for the property and
the financial measures calculated. In Example No. 2 the financial measures such as the Cap Rate are obtained for comparable sales and
are used to calculate the Market Value for the subject property.
Example No 1.
Sale Price (Market Value) $3,165,000
Potential Gross Income: $306,000
Vacancy & Bad Debt Allowance: 4.5%
Operating Expenses $58,000
Mortgage $2,056,000
Mortgage Payment (P+i) $180,538
Number of Suites 30
Total Rentable Area 24,000 Square feet
Note: All figures are annual
Calculate: Potential Gross Income Mulitplier (PGIM)
Effective Gross Income Multiplier (EGIM)
Net Income Multiplier (NIM)
Capitalization Rate (Cap Rate)
Return on Equity (ROE)
Default Ratio (Break even) based on:
Potential Gross Income
Effective Gross Income
Debt Service Ratio (DSR)
Loan to Value Ratio
Price per Suite
Price per Square Foot
Rent per Square Foot per Month
Operating Cost per Suite per Year
Operating Cost per Square Foot per Year
Operating Expense Ratio (OER) based on:
Potential Gross Income
Effective Gross Income
1. Construct an Annual Income and Expense Statement
Potential Gross Income $306,000
Less Vacancy & Bad Debt Allowance (4.5%) 13,770
Effective Gross Income $292,230
Operating Expenses 58,000
Net Operating Income $234,230
Less; Debt Service (P+i) 180,538
Cash Flow Before Tax $ 53,692
2. Calculate the Financial Measures
Potential Gross Income Multiplier (PGIM):
PGIM = MV = 3,165,000
PGI 306,000
= 10.34
Effective Gross Income Multiplier (EGIM):
EGIM = MV = 3,165,000
EGI 292,230
= 10.83
Net Income Multiplier (NIM):
NIM = MV = 3,165,000
NOI 234,230
= 13.51
Capitalization Rate (Cap Rate):
Cap Rate = NOI = 234,230 x 100
MV 3,165,000
= 7.40%
Return on Equity (ROE):
ROE = (NOI – DS) x100 = Cash Flow Before Tax x 100
EGI Equity
= 53,692 x 100
(3,165,000 - 2,056,000)
= 4.84%
Default Ratio (Breakeven):
Based on Potential Gross Income:
Default Ratio = (Operating Expenses + Debt Service) x 100
Potential Gross Income
= (58,000 + 180,538) x 100
306,000
= 77.95%
Default Ratio (Breakeven) cont.
Based on Effective Gross Income:
Default Ratio = (Operating Expenses + Debt Service) x 100
Effective Gross Income
= (58,000 + 180,538) x 100
292,230
= 81.63%
Debt Service Ratio (DSR) = Net Operating Income
Debt Service
= 234,230
180,538
= 1.30
Loan to Value Ratio % = Loan Amount x 100
Market Value
= 2,056,000 x 100
3,165,000
= 64.96%
Price Per Suite = 3,165,000
30
= $105,500
Price per Square foot = 3,165,000
24,000
= $131.88
Rent Per Sq. Foot per Mo. = 306,000
24,000 x 12
= $1.06
Operating Costs Per Suite Per Year
= 58,000
30
= $1,933
Operating Cost per Square foot per year
= 58,000
24,000
= $2.42
Operating Expense Ratio (OER)
Based on Potential Gross Income:
= Operating Expenses x 100
Potential Gross Income
= 58,000 x 100
306,000
= 18.95%
Based on Effective Gross Income:
= Operating Expenses x 100
Effective Gross Income
= 58,000 x 100
292,230
= 19.85%
Summary.
Potential Gross Income Multiplier (EGIM): 10.83
Potential Gross Income Multiplier (EGIM): 10.83
Net Income Multiplier (NIM): 13.51
Capitalization Rate (Cap Rate) 7.40%
Return on Equity (ROE) 4.84%
Default Ratio (Break even) based on:
Potential Gross Income 77.95%
Effective Gross Income 81.63%
Debt Service Ratio (DSR) 1.30
Loan to Value Ratio 64.96%
Price per Suite $105,000
Price per Square Foot $131.88
Rent per Square foot per month $1.06
Operating Cost per Suite per Year $1,933
Operating Cost per Square Foot per Year $2.42
Operating Expense Ratio (OER) based on:
Potential Gross Income 18.96%
Effective Gross Income 19.85%
Example No 2.
Potential Gross Income: $244,800
Vacancy & Bad Debt Allowance: 5.0%
Operating Expenses $49,300
Mortgage $1,685,000
Mortgage Payment (P+i) $147,500
Number of Suites 24
Total Rentable Area 18,720 Square feet
Note: All figures are annual
Calculate the Market Value using the following financial measures
Effective Gross Income Multiplier (EGIM): 9.30
Net Income Multiplier (NIM): 12.50
Capitalization Rate (Cap Rate): 8.00%
Return on Equity (ROE): 5.57%
1. Start by constructing the Annual Income and Expense Statement
Potential Gross Income $244,800
Less Vacancy & Bad Debt Allowance (5.0%) 12,240
Effective Gross Income $232,560
Operating Expenses 49,300
Net Operating Income $183,260
Less; Debt Service (P+i) 147,500
Cash Flow Before Tax $ 35,760
2. Calculate the Market Value based on the:
Effective Gross Income Multiplier (EGIM):
MV = Effective Gross Income x EGIM
= 232,560 x 9.30
= $2,162,808
Net Income Multiplier (NIM):
MV = Net Operating x NIM
= 183,260 x 12.50
= $2,290,750
Capitalization Rate (Cap Rate):
MV = Net Operating Income x 100
Cap Rate
= 183,260 x 100
8.0
= $2,290,750
Return on Equity (ROE):
MV = (NOI - DS) x 100 + Mortgage
ROE
= (183,260 - 147,500) + 1,685,000
5.57
= $2,327,011
Buying a fixer upper
Ask many a home buyer about the type of house they are looking
for and many will reply "We are looking for something we
can fix up and live in (or resell). We like the idea of gaining
some quick sweat equity." The classic "fixer-upper" home.
Unfortunately, there is a bit of fantasy in the notion, though.
First of all, there are many more fixer-upper buyers than there
are fixer-upper properties. Second, the current thinking in many
minds is that anyone can make a killing in the Real Estate market,
which is not always the case. Third,
many buyers totally mis-estimate both the cost and the time involved
in fixer-uppers, severely impacting (and in some cases destroying)
the profit potential. Unless you are fully prepared to deal with
the realities of fixer-uppers rather than the fantasies, it probably
is a good idea to look elsewhere for a home.
This does not mean that there isn't equity to be gained (or profit
to be made) by purchasing the RIGHT property at the RIGHT price.
The important notion is to understand that there are several
factors that will make the difference between winning and losing
in such a transaction.
The Mindset
The first factor that must be understood is that it isn't going
to be easy. The only people who think that finding, buying, fixing
and selling a home is an easy task are those who have never done
it. Those with any experience (even if only once) will tell you
that it rarely is as simple as it appears. In general, it is
best to assume that repairs will cost twice what you estimated,
take double the amount of time and,when finished, the house will
be worth less than expected. If you keep that in the forefront
of your thinking, the chances of being burned are much less.
Foreclosure sales are often good sources for fixer-upper properties.
A couple of resources that specialize in listings of those types
of homes are and . All three of the resources above offer free
trial periods to evaluate their services and search for foreclosure
listings in the area in which you are interested.
Start Out Small
Some of the worst examples of mistakes made by buyers of fixer-uppers
are first-time buyers who bite off way more than they can chew.
Examples of this are houses that have structural problems or
will take an exceptionally long time to repair, or are located
somewhere other than a desirable neighborhood. These can be a
horrible drain on finances, time and peace of mind.
A much better strategy for the inexperienced is to purchase a
home in a desirable neighborhood that is in need of cosmetic
attention--new paint, carpeting, appliances, landscaping and
the like. These repairs can either be handled by the homeowner
or are easily contracted out, saving time, effort and money.
Yes, money can be made on homes needing major renovations, even
if they
are in less popular neighborhoods, but these are jobs for professionals,
not homeowners (and definitely not for first-time homeowners!)
Avoid Surprises
The most expensive situations are often those that are the least
expected--those nasty little (and often big) surprises that jump
out at you. You can avoid many of these surprises, though, with
a couple of easy steps taken BEFORE final commitment to a property.
1) Have the property thoroughly inspected. Have
the inspector detail all obvious (as well as potential)
defects in the property. NOTE: The seller may say "we
are selling the house as-is, so NO inspections." Avoid
this property like the plague.
2) Run the numbers. You must know
the market values for houses in the neighborhood in
which you are interested that need no repairs. Running
the numbers means working them backwards to see how
much equity or profit may be available (or even IF
there will be any) in the deal. You will need to begin
by computing the realistic value of the home when all
repairs are made. From that point, you will need to
subtract any selling expenses you will incur (commissions
and the like) as well as the full cost of repairs and,
most importantly, the amount of desired profit or equity.
Example:
$600,000: Expected Sale Price, Repaired
-40,000: Selling Expenses
-25,500: Repair Expenses
-50,000: Desired Profit/Equity
$485,000: Maximum Property Purchase Price
Don't be deluded into thinking that you'll be able to sell for
more than the market value or do the repairs for less than the
estimates. If the numbers don't fit--with a good amount of "wiggle
room" for more expense or handling costs or if the property
does not sell quickly--don't waste your time or your money!
Summing Up
When considering a fixer-upper, whether for resale or to live
in with increased equity, go into the process fully prepared
so you will avoid many surprises. For your first project, only
consider structurally sound homes in good neighborhoods requiring
cosmetic repairs only. Have any property you are considering
fully inspected and then get firm estimates for all needed repairs.
Most importantly, "run the numbers" to be certain that
the potential for gain is truly there. If you are satisfied on
all counts, you may very well be able to be successful with your
fixer-upper project “Remember
not making a decision is still a decision!
Building a home
Buying a lot and building your dream home may be the way to go. The cost of building will vary widely from $50.00 per square to $300.00 and up.
Basically lots in Florida as far as price goes will run as follows.
Most expensive
Open-water—Atlantic or Gulf
Open-water Inter-Coastal or other Rivers-Lakes
Canal Homes with Open water views (Bay or Atlantic-Gulf)
Canal homes-Boat able and quick access to open-water
Dry Lots—price widely varies based on the community and area.
As of September 2005, per an MLS search, the prices for vacant
lots started at.
Melbourne, $45,000
Melbourne Beach, $375,000
Palm Bay, $40,000
Cocoa, $28,900
Cocoa Beach-there were none available
Titusville, $275,000
There is one problem in finding a custom builder right now and
that is that most of the builders are really jammed since the last
hurricane and also in trying to keep up with the explosive growth
this year (2005) in building new homes, apartments.
Permit prices and restrictions will vary in each community. Generally the more environmentally sensitive the area is, the more restrictions there are in getting a permit. (Since the water is one of the main reason people want to be here, the state and the communities want to keep it that way.
Important:
Regarding pricing. The closer to the water and the deeper the boating,(boat
draft-a 50 foot requires deeper water and wider canals than a
flats boat) the higher the prices.
Another thing to do is find out what flood zone the property is
in per FEMA maps and then talk to a local insurer on how that will
affect your rates. Do this ahead of time.
#In all cases if you find a lot that you like, my suggestion is
that you ask for a letter of build ability from the local zoning
commission as a clause in your sales contract. Always-always, talk
with the county yourself to get the update on the laws.
So, yes, you can build here and it’s done all the time, but make sure you ask all the necessary questions and if you can, get it in writing.
See the Biz directory for builders if that’s the way you want to go. If you want a new home contact a residential agent.
REGARDING BUILDING
Ask the REALTOR that you pick to help find you a good builder that
can respond. Another consideration is to buy a lot and build
later (be careful here as building codes and laws can change
due to density controls) I would first see how long it takes
to get a building permit and then if you get one how long you
can wait. In the Keys when you get a permit there is a limit
of a couple years during which time you have to at least start
the process (bring electric to the site-do a septic check etc)
Since all this varies widely make sure you get all the answers,
Probably best to go the the permit department and have a discussion.
Due to Florida’s stricter building codes, please check out
http://www.brevardcounty.us/buildingcode/home/
Link to the Florida 2004 building code draft
http://www2.iccsafe.org/florida_building_code/
Zoning ordinances For Zoning Information, Contact the Broward
County Community Code Compliance Division at 954-468-3434
The purpose of the Building Code is to protect the safety, health,
and general welfare of the citizens through structural strength,
stability, sanitation, adequate light and ventilation, and safety
to life from hazards attributed to the built environment. This
is accomplished through the implementation of building, plumbing,
mechanical and electrical codes along with various state and local
codes and standards
Information on Complaints Against Contractors:
Don't get nailed! Many citizens in Florida have fallen victim to
dishonest, unlicensed or improperly licensed contractors. Florida
Statute 489 requires all construction contractors to hold a valid
contractor's license prior to engaging in contracting. Always
require that a contractor show you a valid contracting license
before you sign a contract. Some indications that a contractor
may be unlicensed are: the contractor requests a large deposit
or all of the money up front before any work has commenced, the
contractor asks you to pull a "homeowner permit", the
contractor pressures you to sign a contract "today or I
can't give you this special price." To verify licensure
of a contractor, you may call the State of Florida Dep't of Professional
Regulation at 941 338-2373 or search their contractor licensing
database. The City requires proof of licensure from contractors
who pull permits for properties located in the City, so be sure
to require that the contractor pull the permit in his name, not
your name
So always play it safe and do it right. This will certainly help you in the Insurance area also---The extra structural costs for doing it better really pay off if a Storm hits and or you decide to sell
With regard to making any decisions, be sure to check with local and state permit and zoning authorities and a REALTOR and/or a Real Estate attorney
To find contractors, builders and other business vendors see the business directory for the area (Under real Estate section) or contact a local REALTOR for help.
*Regarding, building and building permits, be sure to check with the County and city building departments as the laws change.
