Investing Fundamentals

Does An Exchange Make Sense For Me?

This is the first of a series of articles on items that are of concern to those who own investment real estate. As an owner of investment properties, I hope that this series of articles may be of interest to you.

These articles are written by an investor, for investors. I specialize in investment property in Santa Rosa. I have owned several investment properties, both residential and commercial. I have many years of experience working with investors and investment properties. I believe that investment property owners wish to work with people who understand their concerns, goals, challenges, and special issues.

This article is the first part of a serious I have written on real estate exchanges. You may say, "Why would this be of interest to me?" The answer is that it is wise for investors to be aware of ways to enhance their profit from their investment properties. One important way of doing this is through real estate exchanges. At a minimum, investors should know about options available to them.

If you have ever considered marketing your investment property and deferring taxation on your gain, real estate exchanges may be your entrée to the accomplishment of both these goals. Of course, this does not mean that one should only use an exchange when selling an investment property. There are many circumstances in which selling an investment property without using an exchange is appropriate. An exchange is just one method of selling an investment property. However, in my experience with investment properties, exchanges are an under-utilized tool.


What is an exchange?


An 'exchange,' as it's defined in real estate, refers to a situation in which an investor sells an investment property that they own, and purchases a new investment property, of equal or greater value, while deferring any taxation on the profit of the original property.

It's a common misconception that an exchange means trading your current property for another investment property. Rarely is a direct trade the way that an exchange actually occurs. Much more typically an exchange is just like any other sale. The current property is sold (with an exchange agreement in place), and then the investor buys another property of equal or greater value (again, with an exchange agreement in place). The exchange agreement is a simple matter of mentioning that it's an exchange in the purchase agreement (your Realtor will do this for you), and having a facilitator (an inexpensive third party firm that provides the paperwork and structure necessary to complete an exchange).

What benefits does an exchange create?

Benefits Of Exchanging

There are several benefits of utilizing an exchange to sell your current investment property.

  1. You can totally defer the payment of a potentially large tax bill.
  2. You can control significantly more property than you otherwise could, because your current property is not diminished by taxation, thereby allowing you to exchange into a large property than would otherwise be possible.
  3. Your net worth can end up significantly higher than it would have been if you sold your investment property without an exchange.
  4. You can use an exchange to "shift" your investment property closer to you, physically, without having its value diminished by taxation.
  5. You can move up to a more lucrative and more effective investment property, a larger property which produces more income, without your current property being reduced in value by substantial taxes.
  6. You can consolidate several investment properties (such as several single family homes) into one or two larger, more productive and lucrative properties, which have the added benefit of easier management.
  7. You can control, and therefore profit from, a larger total amount of real estate, because an exchange allows you to own substantially more real estate than you otherwise would have been able to do.
  8. You can move out of the type of property you have now, into a different type of investment property (commercial, office, single family, duplex, four-plex, apartments, etc.), while deferring taxation on the profit from your current property.
  9. You can diversify the types of properties you own. For example, you can exchange from a single family home to duplexes to office buildings, apartments, etc.
  10. You can transition into more properties, or fewer than you have now, for management, convenience, or financial reasons.
  11. You can defer substantial taxes from depreciation recapture.
  12. You can increase your cash flow. For example, you could exchange three single family homes into a more income-efficient four-plex, or a four-plex into a small apartment, thereby potentially increasing cash flow.
  13. You can create more tax shelter, via increased depreciation tax write off on the new property.
  14. You can shift your property (or properties) into a different, more desirable area or neighborhood, without reducing it's value through taxation.
  15. You can move your property (or properties) into an investment that brings you higher monthly cash flow, without reducing it's value through taxation.
  16. You can build your net worth considerably faster than you otherwise would, because your current property's value is not diminished from taxation during the sale.

How An Exchange Can defer Taxation, and Improve One's Net Worth

Deferred Taxes Can Lead To A Larger Property And A Higher Net Worth

An exchange significantly increases the amount of equity that you can keep when you sell a property. This deferred taxation can lead to significant enhancements of your net worth.

Let us say that you currently own a single family home investment property. You wish to enlarge your portfolio, and build your net worth. You are considering the sale of this rental single family home, in order to purchase two single family homes (possibly closer to where you live), a duplex or a small office building.

Exchanging can often allow you to control 2 - 5 times more real estate than would be the case without the exchange. This is possible via the use of leverage, combined with the tax deferment aspects of an exchange.

Here is an example. In this scenario, our investor originally purchased their investment property for $200,000. During the period of ownership, our investor takes $50,000 depreciation. Assume that this investor is contemplating selling this investment property today at $450,000.

Here is what the numbers would look like:

Property Basis

$ 200,000.00


Original Purchase Price

$ 5,000.00


Closing costs at time of purchase

$ 5,000.00


Capital improvements made since time of purchase

$ 50,000.00


Depreciation taken since the property was purchased

$ 160,000.00


Adjusted Basis of property

Capital Gain That Results From Sale

$ 450,000.00


Today's sales price of the property

$ 27,000.00


Brokerage fee upon sale of property

$ 160,000.00


Adjusted Basis of property (taken from above)

$ 263,000.00


Capital Gain ($213,000) & depreciation recapture ($50,000)

Taxes Owed On This Sale (Without An Exchange)

$ 12,500.00


Taxes owed on recapture of depreciation (25% of $50,000)

$ 42,600.00


Taxes owed on capital gain (20% of $213,000)

$ 55,100.00


Total taxes due on this sale (without an exchange)

In this case, if our investor sells this property without using an exchange, they will owe $55,100 in taxes. But if our investor utilizes an exchange to sell their property, the $55,100 tax bill is totally deferred. No taxes are due at the completion of the sale (assuming that an exchange is employed to sell the property).

Deferring $55,100 in taxes is, of course, a worthwhile endeavor. But the power of exchanging comes not only from this tax deferral, but from the significantly higher amount of real estate that the investor controls by using an exchange.

Due to the power of leverage, by deferring the payment of the above mentioned taxes, our investor could potentially control $220,000 - $275,000 more real estate than he/she otherwise would be able to control.

By controlling this extra amount of real estate, our investor experiences several benefits. Among these benefits are possible appreciation based upon $220,000 - $275,000 more real estate. In addition, our investor may experience more tax write off, due to a depreciation schedule based upon a significantly higher depreciation base.

Controlling this amount of extra real estate is significant. If real estate appreciates 10% in a given year, our investor will experience $22,000 - $27,500 more appreciation in that one year than the investor would have if they hadn't utilized an exchange.

To calculate the numbers relevant to you, and to calculate your financial outcome with and without an exchange, click on the following web address: (and click on "Estimate Capital Gains Tax." This web address is one of many that can help you calculate the relevant numbers. It is quite important that you double check any numbers that you calculate on your own with a qualified CPA or tax advisor. Ask your CPA or tax advisor if they are knowledgeable and experienced with handling 1031 exchanges. If they are not, ask them for a referral to someone who has the requisite experience and knowledge.

Tax Advice / Disclaimer

Tax law is complicated, and various circumstances can affect the scenarios listed above. If you are considering utilizing an exchange, or are considering a regular sale of an investment property, it is advisable to consult with a qualified CPA or tax advisor. Request that they run the numbers and provide a personalized tax scenario for you.

The information in the article above is intended as general information, and it's important to not apply this to your individual situation without seeking expert tax advice.

Also, consider calling an exchange expert for your exchange related questions. One such firm (called an intermediary) is Starker Services, Inc. Their telephone number is 800-332-1031. There are many, many other firms that offer this service. To check other firms, do a search at for 'tax intermediary'.

Contact & Biographical Information

If you would like to explore, at no obligation, the sale or exchange of your investment property, please contact me. I may be reached at 707 577-8200, or you may email me at I respond promptly and fully to either type of inquiry.

If you would like to begin the exploration of number scenarios for your Northwest Santa Rosa property, please phone me for the first step, which is a no-obligation, complementary value analysis of your property. This analysis will give you the starting point for the numbers analysis.

I have specialized in real estate sales in the Northwest Santa Rosa area for over 12 years.  For a list of the homes that I have personally marketed in Northwest Santa Rosa, please click here.

As a seller of a Northwest Santa Rosa property, you deserve someone with extensive local knowledge. Here are some details on my actual results:

* Over 104 closed sales in Northwest Santa Rosa

* Over $18,000,000 (million) dollars of closed sales in Northwest Santa Rosa

To see my professional resume, click on here.

Investors are a large portion of my clientele. Well over 50% of my clients are investors. I have owned investment property in Northwest Santa Rosa, and out of state. I have access to several vendors who can accomplish many things for an investor during the marketing period of a property, including painting, landscaping, repairs, etc. I obtain these estimates for the investor, because a large majority of investors live out of the area. I handle all of these matters so that the investor does not need to.

I obtain competitive estimates, and present the investor recommendations based upon many, many years of personal and business experience regarding the improvements (if any) that will make the largest net profit for the investor.

I have tremendous experience in knowing how to optimally intersect the seller's need for continuing cash flow from the existing tenant with the important need to maximize the value of the property during the marketing period. I am highly experienced and knowledgeable about various strategies for handling cash flow issues during the marketing and/or preparation for marketing period.

For client professional references, click here.

If you would like to speak with me regarding the first step in the sale (or exchange) process, you may request a complementary, no obligation market analysis of your current property by phoning my office at 707 577-8200.

If you would like a complimentary, personalized property value analysis, please phone Shayne Bowen at 707 577-8200! (Alternately, you may click here to make a request for a personalized property value analysis.)  
If you are interested in making a purchase or exchange of a property, please phone Shayne Bowen at 707 577-8200! (Alternately, you may click here to request information on potential properties for you.)