How to Use the New Tax Laws to Boost Your Net Worth, Part 3

“Let us consider the reason of the case. For nothing is law that is not reason.” – Sir John Powell

If you’re ready to take profits in an investment real-estate deal, there’s an easy way you can boost your profits by 15% . . . or maybe even more . . . by taking advantage of the Internal Revenue Code.

Matt Turner, the corporate attorney of the Oxford Club, recently reported on a little-utilized IRS rule — found at Section 1031 of the Internal Revenue Code. This tax rule, Turner said, makes possible a technique that “the Donald Trumps of the world use to build vast real-estate empires.”

Section 1031 of the code says: “No gain . . . shall be recognized on the exchange of property held for productive use in trade or business or for investment if such property is exchanged solely for property of like kind.”

What the legal language means is that if you take the money you got from selling an investment property and use it to buy a second investment property, you don’t have to pay any taxes on the transaction. If, for example, you buy a property for $100,000, sell it a year later for $200,000, and then use the $200,000 to buy another investment property, there’s no gain, for tax purposes, on the first transaction.

What this means, in real terms, is that your gain on the first deal is boosted by at least 15% (the capital-gains taxes you don’t have to pay plus any state gains taxes). It also means that you have at least 15% more buying power when you buy your second investment property.

Here’s what you have to do, Turner says, to take advantage of this legal way to stiff the tax man . . .

1. Make sure the proceeds from the sale of your first investment property are used to make another similar (“like-kind”) real-estate investment.

2. Make certain you never actually take control of the proceeds from the first sale but instead use a middleman to take the sales proceeds and buy the new property in your name.

Needless to say, since you’re dealing with the IRS, there are some specific requirements concerning the agreement you make with your middleman — known in tax parlance as a “qualified intermediary.” And if you don’t meet these requirements, you’ll lose your tax benefit.

First, the middleman must enter into a written “exchange agreement” with you to acquire and transfer the property you give up and to acquire the replacement property in your name.

Among other things, this agreement must expressly limit your rights to receive, pledge, borrow, or otherwise obtain the benefits of money from the first sale to make the second purchase. In addition, the exchange agreement binds the middleman to do what he has contracted to do in order for you to get your tax benefit. It also requires you to “assign” your rights (i.e., the right to receive the money from the sale of your property) to the middleman.

Bear in mind, though, that taking advantage of a like-kind exchange does not completely do away with the need to pay taxes. If you sell the second property you acquire and cash out, you’ll have to pay capital-gains taxes.

However, you can continue doing like-kind exchanges, deferring taxes on deal after deal and using “Uncle Sam’s money” to boost the value of your total real-estate portfolio in the process.

An important caveat: It’s not a good idea for an amateur to try to structure a like-kind exchange without professional guidance. You really should hire a tax attorney to guarantee you get the tax breaks you’re looking for.

Meanwhile, the Oxford Club has created an easy-to-understand guide about these exchanges. In it, you’ll find educational examples of all of the documents (exhibits) you’ll need to provide your attorney with to perform this transaction (saving time and money). And you’ll have a more complete explanation of the inner workings of a like-kind exchange, along with examples to ease your comprehension. The name of this report is “Like-Kind Exchanges: How to Bank Real Estate Profits Without Paying Capital Gains Taxes.”