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2. NNN Properties are Ideal 1031 Replacement Properties
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10. Minimum NNN Investments as Low as $100,0000

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Would you like to unlock the equity in your appreciated real estate and not pay capital gains taxes?

Do you have investment real estate that you have owned long enough to build up equity? Would you like to put that equity to work but don’t want to pay capital gains taxes? Did you know that there is a way to sell your property and not pay any capital gains taxes? The way to do this is through a 1031 Exchange and one of the most asset classes to buy is a Triple Net Property “NNN”, for your replacement property which will give you some or all of the following benefits.

• No property management since a Triple Net Property will typically have a lease that requires the tenant to take care of all aspects of the property including maintenance and repairs
• Exchange into a higher value NNN property with potentially more cash flow
• Defer all capital gains and pay no taxes
• Provide additional benefits for your estate through stepped-up basis
• Smart wealth preservation strategy
• Property diversification: 1 to many – many to 1
• Geographic diversification
• Diversify for tax, financial, and estate planning
• Take advantage of leverage
• Be a seller in a seller’s market and a buyer in a buyer’s market (geographically specific)
• Potentially improve depreciation benefits

What is a 1031 Exchange?

In a typical property sale, the owner must pay taxes on the gain or appreciation of the relinquished property. A §1031 tax deferred exchange is the method by which one property can be sold and another “like-kind” property, like a Triple Net Lease Property (“NNN”) can be acquired while deferring the capital gains tax owed on the sale of the relinquished property.

These tax deferred exchanges are authorized by the Internal Revenue Code Section 1031. The “like-kind” definition for real estate is very broad – any real estate is like-kind with any real estate held for investment purposes. For example, raw land would be like-kind with an office building or an apartment property.

There is no limit to the number of exchanges that an investor can do, making it possible to defer the tax consequences indefinitely; however, property that is sold and that are acquired must be qualified property. Properties that do not qualify are primary residences, second homes, personal property, and inventory. Most other investment property qualifies.

One of the primary advantages of completing a 1031 exchange is the ability to defer taxes on the sale of your property and reinvest 100% of the proceeds. (Combined Federal and State tax rates can be as high as 25%). Other benefits include the ability to diversify your investment real estate by geographic location, property type, property quality, and potentially increase or create positive cash flows.

Buying a Triple Net Lease Property (“NNN”) as your 1031 Exchange Replacement Property

IRC Section 1031 requires that the new (replacement) property qualify as property held for use in a trade or business or for investment. A Triple Net Lease Property, also known as a “NNN” deal, qualifies as such a property.

NNN investments are typically single-tenant retail properties leased to tenants with high credit ratings on "net, net, net" terms (hence the NNN acronym), meaning the tenant is responsible for real estate taxes, insurance, and all maintenance.

They are typically new or nearly new, have no management responsibilities, a long-term lease is in place to a quality tenant, they have stable cash flow and attractive financing in many cases.

Triple Net Lease investing (NNN) involves buying free standing buildings that are leased to credit-worthy tenants. Tenants can be everything from a Walgreen Drug Store to a discount chain store such as Family Dollar or Dollar General.

Other net lease properties include bank buildings such as Bank of America, fast food outlets such as McDonalds, Burger King or Taco Bell or auto service and auto part stores like Auto Zone or Advance Auto. NNN properties are typically leased to tenants for 10 to 25 years and many have corporate guarantees.

Not all Leases are Created Equal

When considering a triple net lease property as a replacement property in your 1031 exchange it’s important to understand the nuances of commercial tenant leases. Triple Net is often missed used in describing the investment. The following will give a brief overview of the different types of leases that might actually be in place when you are looking at what is being marketed as a NNN lease.

Bond Lease

The tenant is fully responsible for operating expenses, maintenance, repairs, and replacements for the entire building and site, without limitation. These types of leases will typically yield the lowest return on investment of the different types of leases.

Triple Net Lease “NNN”

This lease is similar to the bond lease except tenant expenditures for capital improvements are limited, usually in the final months of the lease. The tenant is still liable for all property costs including fixed and operating expenses.

NNN Lease

This lease is like a NNN lease with the exception that the landlord is responsible for structural components, such as the roof, bearing walls, and foundation.

Modified Net (or Modified Gross) Lease

In this type of lease, the tenant pays its own utilities, interior maintenance and repairs, and insurance. The landlord pays everything else, including real estate property taxes.

Gross Lease

The tenant pays a fixed amount for their rent and the landlord pays everything else including real estate property taxes, insurance, repairs and interior maintenance.

1031 Exchange Timeline

• The identification of the potential replacement properties must be done within 45 days from the close of escrow on the relinquished property (the 45-day rule).
• The investor has 180 days from the close of the relinquished property to close escrow on one or more of the properties that were previously identified (the 180-day rule).

1031 Exchange Property Identification Rules

The IRS has established strict rules for Exchangers when identifying replacement properties for their 1031 exchange. These strict rules were created in order to prevent Exchangers from identifying mass number of properties and never actually purchasing what they have identified. In order to control this over identification issue, the IRS has come up with three identification rules that must be followed for a valid 1031 exchange. These rules include the Exchanger complying with the Three (3) property rule, OR the 200% of gross sales price (relinquished property) rule, OR the 95% Rule.

Three (3) Property Rule

Under the three-property rule, an Exchanger can identify up to three (3) properties of any aggregate fair market value. The rule further explains that the Exchanger does not need to purchase all three (3) properties identified, the Exchanger can purchase just one of the properties and still complete a valid exchange.

Although an Exchanger may be confident that the purchase of their desired replacement property will be made, The Three (3) Property Rule can be used as a “backup” mechanism if an Exchanger’s desired property experiences any problems which invalidate the use of that property in the exchange.

200% Rule

If the Exchanger desires to identify more than three properties (as described in the Three (3) Property Rule), up to 200% of gross sales price (before any deductions) of the relinquished property may identified in any number of properties.

For example, an Exchanger identifies four (4) properties with an aggregate value of 125% of the gross sales price of the relinquished property. This identification does not comply with the Three (3) Property Rule since more than 3 properties were identified, however, it does comply with the 200% Rule since the aggregate value of the 4 properties identified are less than 200% of the gross sales price of the relinquished property.

The Exchanger does not need to purchase all of the properties identified under the 200% rule.

95% Rule

For the Exchanger, the 95% Rule is the riskiest of the three identification rules in a 1031 exchange. Under the 95% rule, if an Exchanger identifies more than three properties with an aggregate fair market value greater than 200% of the gross sales price of the relinquished property, the Exchanger must purchase at least 95% of the fair market value of the properties identified.

For example, an Exchanger identifies 10 properties with a fair market value of $1,000,000 which is 215% of the gross sales price of the relinquished property of $465,116. Under the 95% Rule, the Exchanger must purchase at least 95% of the fair market which would be $950,000. Additionally, there is no limitation on the number of properties that comprise the 95%. In effect, the Exchanger must purchase all of the properties identified. If even one property is not purchased, the entire exchange will be subject to capital gains.

The property identification rules of a 1031 exchange can be quite confusing. It is recommended that you consult 1031 Exchange Strategies, Inc., your CPA, or a Qualified Intermediary regarding the usage of these complex rules.

Frequently Asked Questions

WHAT IS A 1031 EXCHANGE?

Internal Revenue Code Section 1031 provides that no gain or loss will be recognized on the exchange of any type of business use or investment property for any other business use or investment property. 1031 Exchanges are not really exchanges in the context of two-party barter. Instead, they are typical sales and purchases that involve the same exact ingredients as any other sale or purchase, without the capital gains. The only real difference is the investor is increasing his selling and buying power by electing to avoid the drain of taxes under Section 1031 regulations. No other aspects of the transaction are affected.

WHO SHOULD CONSIDER A 1031 EXCHANGE?

Anyone who is thinking about selling a business use or investment property should consider affecting a 1031 Exchange. An Exchange offers the astute investor an opportunity to reinvest the federal capital gains that would normally be handed over to the IRS and put that money to work for himself. You work too hard to simply pay the tax without carefully considering this reinvestment option. Essentially, 1031 Exchanges should be thought of as an interest free loan from the IRS; one in which the principal may be increased through subsequent exchanges and may never require repayment, if you plan properly.

WHAT IS "INTERNAL REVENUE CODE SECTION 1031"?

Section 1031 of the Internal Revenue Code relates to the disposition of property that is held for use in productive trade or business or held for investment. If performed properly, code section 1031 provides an exception to the rule requiring recognition of gain upon the sale of property. The current Federal tax rate (maximum) on long term capital gains is 15%, plus any applicable state taxes. Long term capital gains are not taxed as ordinary income.

The most important reason is to be able to defer potentially taxable gain one may realize from a sale of the property. This way one may be able to use All OF THEIR EQUITY to acquire another property, instead of the amount of equity left over after paying applicable Federal and State income taxes on their gain. Additionally, the ability to go from one type of property to another allows an investor to utilize these other concepts: Leverage, Diversification, Cash Flow, Consolidation, Management relief, and possibly Increase their Depreciation.

It is possible, under the current IRS Section 1031 rules, to continue to exchange properties, using all of your equity, thus increasing your portfolio Net Worth much faster than were you to sell properties, pay the taxes, and then acquire another property with the remaining equity. For an exchange to be 100% tax deferred, the Exchanger must acquire replacement property that is of equal or greater value and spend all of the net proceeds from the relinquished property. Many specific requirements must be satisfied in order to complete the exchange properly.

WHAT IS 1031"LIKE KIND" PROPERTY?

This means that business property or property held for investment may be disposed of to a buyer (sold), set up with a "Qualified Intermediary", put into escrow, which will document the transaction as an exchange, and within the codified time frame, repurchase replacement property of "like kind" thereby completing the exchange. It is not required that exactly the same type of property is acquired. Like kind property that can be exchanged under the current meaning of Code Section 1031 includes a wide variety of PROPERTY THAT IS HELD FOR PRODUCTIVE USE IN A TRADE OR BUSINESS, OR, PROPERTY THAT IS HELD FOR INVESTMENT. "Like kind" property can include, but is not limited to any of the following, provided it is held for investment: commercial, single family rental property, condos, raw land, apartments, vacations home, second home, duplexes, industrial properties and a Leasehold Interest of 30 years or more. A person’s PRIMARY RESIDENCE does NOT come under the rules of Section 1031, and is specifically EXCLUDED, as is property held "primarily for resale" or dealer property. Exchanger, either actually or constructively. If an Exchanger does not spend all of the proceeds from the sale of the relinquished property, he/she will have actual receipt of the balance not spent and pay taxes on that amount.

A common misconception to "like kind" is that the properties being exchanged be of "similar use". This is simply not true. A commercial property can be exchanged for an apartment complex or bare land exchanged for a single- family rental.

WHAT IS IRC SECTION 1034 PROPERTY?

IRC Section 1034 encompasses a primary residence only. A taxpayer is only allowed one primary residence, therefore, by reason of default; any other real property could be considered possible 1031 property. The only condition is that it meets the guidelines of Section 1031.

WHY EXCHANGE PROPERTY INSTEAD OF JUST SELLING IT?

The most important reason is to be able to defer potentially taxable gain one may realize from a sale of the property. This way one may be able to use All OF THEIR EQUITY to acquire another property, instead of the amount of equity left over after paying applicable Federal and State income taxes on their gain. Additionally, the ability to go from one type of property to another allows an investor to utilize these other concepts: Leverage, Diversification, Cash Flow, Consolidation, Management relief, and possibly Increase their Depreciation. It is possible, under the current IRS Section 1031 rules, to continue to exchange properties, using all of your equity, thus increasing your portfolio Net Worth much faster than were you to sell properties, pay the taxes, and then acquire another property with the remaining equity.

WHEN IS A 1031 TAX-DEFERRED EXCHANGE APPLICABLE?

It is applicable when the property in question falls within the "like kind" definition and the principal intends to BUY another property of "like kind" within 180 calendar days following the close of escrow from the SALE, and when the Investor has a recognizable gain. Remember, under the delayed exchange parameters, there is a maximum of 180 calendar days to purchase replacement property.

If the principal is not sure prior to closing the sale property, it is a good idea that the transaction is structured as an exchange rather than a sale. Otherwise, if the escrow is closed without the exchange protocol in place, the principal will have receipt of proceeds and cannot perform an exchange. If the exchange is "set up", the principal has the option of deferring taxes.

WHAT IS THE CURRENT IDENTIFICATION PERIOD, AND CLOSING TIME TO ACCOMPLISH A DELAYED 1031 TAX DEFERRED EXCHANGE?

After an exchange, has been "set up", by contacting a Qualified Intermediary prior to closing a sale, the Seller, Exchanger, may identify up to three (3) potential properties they MAY intend to acquire, within 45 days of the close of the "sale" escrow.

One can list, or identify, more than 3 properties, however these properties cannot have an aggregate value of 200% or more of the sale property. If more than three (3) properties are identified, and the value exceeds 200% of the sale price, then you must close escrow on 95% of the identified properties. Escrow must close, on at least one of the identified properties (or all of the properties if using the 95% rule), within 180 calendar days from the date of the close of the sale escrow. Be sure to check with your legal and/or tax advisor.

WHAT HAPPENS TO THE MONEY?

It is imperative that the Exchanger (who is the owner and seller of the property) does NOT receive any money. The Seller’s net proceeds are wired to the Intermediary into a separate, interest bearing account. Each exchange has its own account; therefore, you must call the Intermediary BEFORE wiring to obtain the account number.

At the closing of the replacement property, the funds required to close the transaction will be wired from the exchange account held by the Intermediary. In the event, there are insufficient funds in the exchange account to close your escrow/ closing, then the Exchanger will have to deposit the additional funds required to close the escrow/closing.

WHAT HAPPENS WHEN THE EXCHANGER OBTAINS A NEW LOAN FROM AN INSTITUTIONAL LENDER?

The Intermediary does not need to see or sign any of the lender’s documents. This is the Exchanger’s loan and only the Exchanger should be signing. Most lenders do not have a problem with the Qualified Intermediary inserted as the Exchanger’s Name on Instructions or Settlement Statements. However, if the lender does not want to see an Intermediary’s name on your statements or instructions, you can eliminate their name on items sent to the lender.

CAN I TAKE CASH OUT OF A 1031 EXCHANGE?

You cannot take cash out of an exchange without creating a taxable event. If an Exchanger elects to take some of the equity out of the sale proceeds in the way of cash or a note, this is called "BOOT" and is taxable. However, to avoid taxable boot, an Exchanger can opt to refinance after the exchange transaction is completed.

WHEN IS THE BEST TIME TO NOTIFY RELATED PARTIES ABOUT THE INTENT TO COMPLETE A 1031 EXCHANGE?

The IRS requires you to notify the buyer of your relinquished property and the seller of your replacement property of your intent to complete a 1031 Exchange. However, you should wait until all terms of the Agreement of Sale have been agreed upon before making this notification. Ideally, you would like to have the cooperation of your buyer and seller but it is not necessary, as regulations simply require that they be notified in writing.

CAN I CLOSE ON MY REPLACEMENT PROPERTY BEFORE I HAVE A BUYER FOR MY RELINQUISHED PROPERTY?

Yes. This exchange process is known as a Reverse Exchange. The IRS has adopted regulations specifically for Reverse Exchanges. The Reverse Exchange receives basically the same benefits as the Deferred Exchange and the Revenue Ruling sets up the guidelines needed to structure the Reverse Exchange. To make the exchange work, someone other than yourself (usually your intermediary) must take title to one of the properties until you are ready to convey the relinquished property to a buyer.

HOW DO I REPORT MY 1031 EXCHANGE TO THE IRS?

Initially, your 1031 Exchange is reported on the IRS form 1099S which should indicate that you are effecting a 1031 Exchange and will receive property as consideration for the sale of your relinquished property. IRS Form 8824 must be completed as part of your annual federal return. In addition to determining your realized gain, recognized gain and your new basis, this form will ask the date you sold your relinquished property, identified and acquired your replacement property. Form 8824 is actually a supporting form for IRS Form 4797. Capital gains and/ or losses will be reported on schedule D of IRS form 1040. The income, expenses, and related financial information received for rental properties must be reported on Schedule E of IRS Form 1040.

WHAT ARE MY CHANCES OF BEING AUDITED?

The IRS currently audits approximately one (1)% of all returns. A 1031 Exchange is not likely to increase your chances of being audited.

IF I HAVE ALREADY SIGNED MY AGREEMENT OF SALE, IS IT TOO LATE TO INITIATE A 1031 EXCHANGE?

No, as long as you have not settled on the property you are selling, a 1031 Exchange can still be completed. However, once the closing occurs, it is too late to utilize the advantages of Section 1031.

18) WHAT IS NEEDED WHEN THE EXCHANGER IS A PARTNERSHIP, CORPORATION OR TRUST?

There is nothing different in how the exchange is handled, but the Intermediary will need to see a copy of the Trust Agreement, the Partnership Agreement, or a Corporate Resolution.

WHAT IS A QUALIFIED INTERMEDIARY?

The Intermediary is the entity that structures, consults, guides and documents the exchange transaction from beginning to end. A sound Intermediary will provide safety and security for the funds and provide technical experience to maintain the integrity of the exchange. They do not replace competent tax or legal advice. Quite the contrary, they are not allowed to give tax or legal advice.

WHAT IS BOOT?

Boot is defined as any "NON-LIKE KIND" property received by the Exchanger in the exchange and it is taxable.