PART ONE

TAX DEFERRED LIKE-KIND EXCHANGE The Rapid Route to Asset Growth How to make your vacation property a productive element in a financial plan. • The IRC (Internal Revenue Code) permits a means by which payment of capital gain on appreciated real estates may be deferred. • By selling appreciated assets using the like-kind exchange process, an investor continues to get the use and benefit of capital to increase growth in assets, especially at times when the interest rates are low. The exchange tactic provides the capability to use growth in equity to move up to properties of greater value, with potential for further growth. • By strategic acquisitions, the low tax base, which is the residue of tax-deferred exchange, may be mitigated in the final phases of the plan.

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1185 Duck Road, Duck, NC 27949

EXCHANGE INTERMEDIARY

BUYER

CASH RELINQUISHED PROPERTY

RELINQUISHED PROPERTY TA X PAY E R

INTERMEDIARY

REPLACEMENT PROPERTY

CASH REPLACEMENT PROPERTY SELLER

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1031 LIKE-KIND EXCHANGE The exchange property must qualify according to the text of IRS 1031. ‘. . gain or loss is not recognized when property held for productive use in trade, business or for investment is exchanged for like-kind property to be held for productive use in trade, business, or for investment.” Such properties include retail operations, warehouse or office property or property which is rented and generates income. Land bought for development also qualifies for likekind exchange – these are all real estate acquired for investment. Personal residences, whether first or second homes do not qualify. Equities such as stocks and bonds are not real estate and do not qualify. Notes: 1. Property ‘HELD’ Length of time is not specified. 2. ‘INVESTMENT USE’ This must be demonstrated. Rental history or tax records are important. Personal use of ‘investment’ property i.e. vacation rental homes – must not exceed the statutory 14 days or 10% of days rented. 3. EACH PROPERTY involved in the exchange must qualify as investment property. 4. CONTINUITY OF INVESTMENT is the intended goal of like-kind exchange.

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THE EXCHANGE PROCESS Property is ‘RELINQUISHED’ and ‘REPLACED’ to fulfill the ‘EXCHANGE’ INTENT. No property is bought or sold by the taxpayer. RELINQUISHED “OLD” Property

REPLACED “NEW” Property INTERMEDIARY “Safe Harbor”

• Funds must pass through a qualified third party • No cash can be allocated to the taxpayer. • The intermediary or accommodator holds and disburses funds • The intermediary is the legal vehicle through which the properties are conveyed or exchanged. • The intermediary must be a person or entity ‘at arms length’ who has fiduciary responsibility. ‘QUALIFIED INTERMEDIARY’ • Title Insurance Company • Realty Exchange Entity practiced in the work of Intermediary • 3RD Party Attorney NOT ‘QUALIFIED’ ARE THE FOLLOWING • Closing Attorney • Personal Accountant • Friend or Relative

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DOCUMENTATION The intent to exchange must be documented from the earliest stage of selling and the initial stage of buying. SELLING • Indicate intent on listing form. • Include language regarding 1031 like-kind exchange in any other contract. • An addendum may be added prior to closing. BUYING • Include appropriate language in any offer. • An addendum may be incorporated between contract and closing. IDENTIFYING • Replacement property must be identified, in writing, within 45 days after closing a relinquished property. This should include the legal description and address of the property. (More of this to follow in “TIMING.”)

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LIKE-KIND EXCHANGE It is desirable that the agreement include provisions whereby both parties agree to cooperate in the taxpayer being able to bring about a like-kind exchange. Language to be included: SELLER: Like-kind Exchange: “Buyer herby covenants and agrees to use its reasonable efforts and diligence to assist and cooperate with seller in effectuating a like-kind exchange under Section 1031 of the Internal Revenue Code of 1986, as amended (“Section 1031”), including, without limitation, executing and delivering any and all documents reasonably required in accordance with agreements of the parties set forth. Buyer agrees to execute an Assignment Agreement at the request of the Seller. The buyer shall not incur any additional costs, expenses, liabilities, obligations or other financial exposure with respect hereto.” BUYER: “This property represents the replacement property for buyer’s like-kind exchange Seller agrees to execute an Assignment Agreement at the request of the Buyer at no additional cost or liability to Seller. Buyer and seller will remain ultimately liable for all contract obligations and settlement adjustments.

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PROCEEDS All Proceeds Must Pass Trough The Intermediary 1. ALL OF THE FUNDS at closing must be applied to the next part of the transaction, the replacement property. 2. ALL OF THE FUNDS must be deposited and held in trust by the Intermediary. 3. This means that the replacement property must be the same price or greater than the relinquished property.

TIMING An important sequence of events and documentation is to be followed. RELINQUISHED PROPERTY • Must be ‘under contract’ or closed prior to formal identification of replacement property. IDENTIFICATION OF REPLACEMENT PROPERTY • Must take place within 45 days of closing on relinquished property. • This must be in writing and the legal description and address of the property given . ACQUISITION OF REPLACEMENT PROPERTY • Must take place within 180 days of closing on relinquished property.

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REPLACEMENT PROPERTY 1. Taxpayer may select up to 3 properties. 2. The total value of the replacement properties must equal to or exceed the net proceeds from the relinquished property. 3. The identified, replacement properties may be anywhere in the United States.

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PART TWO

RAPID ROUTE TO ASSET GROWTH In areas where real estate is appreciated rapidly, the like-kind exchange capability can be the basis of a long-term investment plan.

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STRATEGY FOR 12-15 YEAR PLAN 1. Select and acquire beach property in a location and condition that will generate maximum appreciation. Plan to invest 20% of your own capital in the endeavor. (Closing costs are an additional expense.) On a $250,000 property, this would require an initial capital outlay of $50,000. 2. Hold and Maintain the property over 4-5 years. See that the rental company makes every effort to rent the property as much as possible. Personal use in the high season should be no more than 14 days. Low and off-season counts as personal maintenance/ management time. 3. Watch the Outer Banks real estate market for the next deal. What areas are showing the greatest increase in value? Where are the best opportunities? Different parts of the Outer Banks grow at different rates. 4. Be ready to go after the next property within 4-5 years, when the present property shows a leap in value and a promising property, house and/or land presents itself. 5. Repeat this two or three times over 12-15 years and you will increase your equity from $50,000 to $500,000 plus have income producing property.

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EXAMPLES OF PLAN

WHAT NEXT?

Investment #1 Purchase Price ......................................... $250,000 Capital Outlay .............................................. 50,000 Plus Closing Costs Loan .......................................................... 200,000 Growth In Value Over 4-5 Years ............. $375,000 Sell/Pay Off Loan ..................................... $195,000 Cost Of Sale ............................................... 20,000 ........................................................... ($215,000) REMAINING EQUITY ............................... $160,000

1. Continue in the same track. Buy several vacation properties. Use your equity to get more loans and take advantage of low rates and generate good cash flow. 2. Diversify into other types of real estate. Possibly more income, less hazard from elements.

Investment #2 Purchase Price ......................................... $450,000 Rolled Over Equity .................................... 160,000 Plus Closing Costs Loan .......................................................... 290,000 Growth In Value Over 4-5 Years ............. $650,000 Sell/Pay Off Loan ..................................... $280,000 Cost Of Sale ................................................ 40,000 ........................................................... ($320,000) REMAINING EQUITY ............................... $330,000 Investment #3 Purchase Price ......................................... $800,000 Rolled Over Equity .................................... 330,000 Plus Closing Costs Loan .......................................................... 470,000 Growth In Value Over 4-5 Years ..... $1,100,000 Sell/Pay Off Loan ..................................... $450,000 Cost Of Sale ................................................ 50,000 ........................................................... ($500,000) REMAINING EQUITY ............................... $500,000

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WAYS TO MITIGATE CAPITAL GAIN AT END OF TAX DEFERRED CYCLE 1. Pyramid your vacation home into other income producing property with a steady income to supplement regular income. This is a useful tactic when investor is ready to retire and is reducing regular income. 2. Do the same as (1), only for estate planning purposes, put the property into a charitable remainder trust. This way, you and your heirs still get the benefit of the income or proceeds from the sale TAX FREE. At your death, 10% of initial value goes to a designated charity, the remainder goes to your heirs. 3. Refinance after one year and use equity for other investments. 4. Sell the property – take cash which will generate least tax burden in one year. Then take back a note for the rest. Benefit – Equity is cashed out with interest! This again provides retirement income. Tax on income from equity would be at a lesser rate and spread out over several years. 5. Live in your appreciated property as a personal residence for two years. Then sell as first home. This way you are allowed up to $500,000 (2 people) free of taxation.

If you have any questions please call Lilias Morrison, Real Escapes Properties, 800-261-2181.

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1185 Duck Road, Duck, NC 27949