When I closed my first tax deferred exchange, some time in the late 70′s, I was elated. Next to Neil Armstrong I’d taken mankind another step along the path of evolution. At 27 I thought I’d scaled the mountaintop and was about to plant my personal flag on the summit. What else could I possibly do that was better than that?
Turns out quite a bit, but anyone with a lick of common sense woulda known that. Though that particular 1031 was well advised, and double/triple checked by my client’s tax guy, I soon learned from a few mentors the lesson to be learned before the fact, about doing tax deferred exchanges. In much the same way we became stalkers when it came to ice cream and candy as kids, real estate investors will, more often than not, treat exchanges similarly.
The penalty for the later is infinitely harsher than the former for sure, but usually not discovered as such ’till the barn door has been closed.
Let’s work backwards.
What folks find out when they reach retirement after three or four decades of deferring capital gains repeatedly on their various investment properties, is that they own a lot of high income, (often high maintenance) low tax shelter income producing machines. Which is better than no income, I get it, but when you pull the chord on your retirement, whatever you have is generally, well, what yer gonna have. Sure, net income will rise in a perfect world.
Um, what were the two key words in that last sentence? 
Every time a property’s capital gain is deferred, the investor takes that Adjusted Cost Basis with them to the next property(s). This does two things immediately.
1. It lowers your annual depreciation on the next properties, relative to what it woulda been sans a 1031 exchange.
2. It pretty much guarantees a higher capital gain on the next property(s) regardless of how much, or even if those newly acquired properties in fact appreciate one dime.
Now extrapolate 35 years of constant exchanging. Each time the above two factors’ impact is multiplied, and not in your favor. Before you know it, your adjusted cost basis, (not connected to real life in any way, shape, or form) is about a buck fifty. Your annual depreciation shelters about twice that much a year. I’m jokin’, but it ain’t funny when you think about it, is it?
Not hardly.
I’ve seen this scenario play out countless times. Ending up at retirement with a buncha properties generating cash flow nearly, or in some cases, literally unsheltered by depreciation, is a bumpy road to travel. Add to that an aging group of buildings, and you’ve got the perfect recipe for increasing operating expenses too. Either way, your after tax income — the only freakin’ income that’ll buy you a burger ‘n fries in the first place, is locked in naked as a jay bird every April 15th.
All this trauma and drama can be easily avoided through the use of Purposeful Planning. And the congregation said, ‘Duh’.
Ya wanna hit yer golden years with as much tax sheltered and tax free retirement income as possible. Many astute real estate investors retire with less gross income than lifetime traders, but with far more after tax income. Is there ever too much after tax retirement income?
Don’t answer, it’s a rhetorical question.
BawldGuy Takeaway: Look at the tax deferred (1031) exchange as merely another tool in your toolbox It’s analogous to a hammer. They’re great for poundin’ nails, but leave much to be desired as drills. Know what I mean, Verne?
Give me a call and we’ll find out how your situation can be Purposefully Planned to avoid this scenario. 619 889-7100. Email works fine too. Have a good one.
Related posts:
- Tax Deferred (1031) Exchanges — Not Always The Right Strategy — An Example
- Easter Island Has No Statue Honoring 1031 Tax Deferred Exchanges
- 1031 — Tax Deferred Exchanges — 200% Rule
- More Definitions For Real Estate Investors Tax Deferred Exchanges
- California Real Estate Investors Using 1031 Exchanges To Turbo Charge Portfolio
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