Tax-free real estate exchanging, once practiced largely on the West Coast, is catching on here.
About 200 local brokers, agents and other professionals are affiliates of the Metropolitan Washington Real Estate Exchangors, a loosely knit group headed by Charles Huggins, a Bethesda property broker. An estimated 5,000 to 6,000 real estate brokers take part in similar organizations around the country, and as many as 1,000 at a time gather for conferences and seminars aimed at bartering farms, houses, timberland, Caribbean resort hotels, gas stations and even mineral rights on remote, underdeveloped acreage.
Exchanging is becoming popular here, says one leader in the local exchangor group, Gay Thompson of Victorian Real Estate Inc. in Washington, "because property owners and real estate people are becoming far more tax-conscious and sophisticated about their investments." They are also far less willing to hand away big chunks of their profits in an inflationary economy to the federal treasury.
Rather than lose 20 to 25 percent of their gains through an outright sale of a rental property or land, investors here increasingly want to swap equities with someone, whether the property is thousands of miles distant or a few blocks away.
As long as equivalent ownership interests in properties of "like kind" held for investment or business are merely traded from one party to another - and no actual sale occurs - Section 1031 of the Internal Revenue Code stipulates that no gain be recognized for federal tax purposes,and no capital gains levy be assessed.
For example, the owner of three acres of undeveloped land that might have increased in value by 400 percent over several years can trade his or her inflated equity for another investor's equity of equivalent value in rental apartments, a farm or a neighborhood commerical property and not be taxed.
Each owner's tax liability is rolled over, or deferred, until the equity is sold. There is no limit on the number of tax-deferring exchanges property owners can make, and many investors seek to extend the tax-free period for as long as possible.
The owner of the undeveloped land could trade up successively during a 15-year period from apartment buildings to a cattle ranch to a highly profitable office building, making maximum use at each swap of the growing acquisition power of the untaxed equity. The deferral of taxation amounts to an interes-free loan from the federal government for such a property owner and is a creative way to get far better property than the initial investment.
The flexibility and benefits of taxdeferred exchanges can be illustrated by a transaction Gay Thompson conducted on her own behalf.
She owned a vacant rowhouse in the Shaw area of Northeast Washington that she intended to rehabilitate for rental or sale. A local builder active in restoration on the same street expressed interest in buying Thompson's property for $27,500. Thompson, however, calculated that if she sold the house outright she would be hit with $4,000 in capital gains taxes, money that could be conserved and put to work through an exchange. The builder had no suitable properties that Thompson wanted via a swap, so she came up with a better idea.
Thompson had been interested in buying three rental houses in Knoxville, Tenn., that were on the market for $64,500 and could be acquired with a $12,500 down payment.
If the District builder would acquire the Knoxville houses for $12,500, Thompson reasoned, they could exchange equities tax free. Thompson's equity in the Shaw property was actually $18,500 (she had a $9,000 mortgage on the house), so she refinanced the property and placed a new $15,000 mortgage on it. This cut her equity down to $12,500 ($27,500 value minus $15,000 debt), equal to the builder's prospective equity in the Knoxville houses.
The builder and Thompson made their trade - he taking title to the Shaw property, assuming the $15,000 new mortgage, and she taking title to the houses - in the course of the escrow closing in Knoxville.
When it was all done, the builder had precisely what he wanted - a house to renovate for future sale and profit, at a cost of $12,500 - and Thompson had everything she wanted and more.
From her vacant $27,500 property, she had parlayed her holdings into three homes in Knoxville valued at $64,500, producing a net rental income of several hundred dollars a month plus significant new tax deductions for depreciation, mortgage interest and maintenance. Besides this, however, she took her $6,000 in proceeds from the Shaw house refinancing ($15,000 new mortgage), and brought two income-producing rental houses in York, Pa., worth $26,000 together.
Her balance sheet from the one Shaw exchange thus included five houses valued at $90,000, new rental income, new tax shelters against her ordinary income, new capital assets growing with inflation - and not a dollar paid out in federal taxes in the process. Not bad at all for a little bit of barter. CAPTION: Illustrations 1 and 2, no caption, By Robin Jareaux - The Washington Post