Managing Your Money: A Profitable Exchange

Using 1031 tax-deferred exchanges can significantly cut your tax bill.

September 1, 2000

I loved playing Monopoly as a kid, and I’ve done the same thing in real life,” says Paula Cobb of her personal real estate investment portfolio. “I buy everything I can get my hands on.”

Her latest purchase is a 15,600-square-foot commercial building in downtown Poway, Calif., that will function as an annuity in the years ahead. “That’s my retirement,” she says. “In a couple of years, it’ll be cranking out $75,000–$100,000 annually, and I won’t have to work.”

Cobb, who, with her husband, Joe, owns two Realty Executives offices in suburban San Diego, says that 1031 tax-deferred exchanges are central to her investment strategy.

“You save big bucks with exchanges,” she says. “If you have investment houses or buildings that have appreciated in value, you’re liable for a lot of taxes when you finally sell them. Over the years, you can lose a lot of equity that way. That doesn’t happen with exchanges.”

How do exchanges work? Basically, you’re given 180 days, or six months, from the time you sell a property to reinvest the money in another building or buildings. During that time, the money is held by what’s called an accommodating firm, or exchange facilitator, which functions almost as a bank and pays you interest. “It’s really not that different from a regular sale,” says Cobb. “Everything is handled by the escrow companies.”

The deal for the commercial building, she adds, was the most complicated exchange she has attempted. The building, which is made of concrete block and was constructed in 1978, cost $1.2 million.

To get the $400,000 downpayment, Cobb sold two houses she owned, one in Claremont and another in Escondido, and refinanced two others, including her personal residence. “I signed a contract for the commercial building in the summer of 1999,” she says, “and I had until Feb. 8, 2000, to sell the other properties and get the rest of the money together. [By early January] I was still $35,000 short. I basically had 10 days to sell the Escondido house, or I was going to wind up paying $80,000 in taxes.”

At the last minute, a buyer materialized. “He closed on the house on Feb. 7,” Cobb says, “and I closed on the commercial building on Feb. 8, with 20 minutes to spare.”

The building, she says, is an excellent opportunity for a number of reasons. “No. 1, it’s full of small offices--300-700 square feet--in an area where small offices for doctors, insurance companies, and accountants are hard to find. No. 2, it’s been mismanaged.”

When she bought it, she says, there were no vacancies. Rents, however, were significantly below market rate. Also, about a third of the tenants had no leases.

“The first thing I did was raise the rents from $1 to $1.40 per square foot and put everyone on a lease,” she says.

She’s also beginning an ambitious exterior renovation program, which is being partially funded by the city. “The building is in a redevelopment area, and the city is giving landlords $10,000 loans for renovations if they put up $5,000 of their own money,” she says. “And if you keep the building for three years, the loans are forgiven.”

Looking ahead, Cobb says another exchange is possible: “The next step would be a shopping center of some kind. Sometimes I drive myself crazy thinking about what to do next, figuring the angles.

“The deals are out there. You just have to look.”

Robert Sharoff is an architectural writer for The New York Times, Washington Post, Chicago Tribune, and Chicago Magazine. With photographer William Zbaren, he has produced books highlighting the architecture of Detroit and St. Louis. He is a former senior editor with REALTOR® Magazine.

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