FEATURE ARTICLE, MARCH 2008

THE NUMBERS GAME
IPX 1031 unveils a new investment opportunity for players seeking diversification — and, of course, tax benefits — in their investment portfolios.
Kevin Jeselnik

Investment Property Exchange Services (IPX 1031) is a qualified intermediary that offers a variety of exchange solutions nationwide. The company recently unveiled a new tool to the investment market that will allow for greater diversification for investors seeking to utilize the 1031 exchange or similar investment program.

Structured Sale Program

The Structured Sale Program is unique to the qualified intermediary industry, and is based on IRS Tax Code Section 453.

“What we are doing now is mixing Section 1031 [tax-deferred exchanges]  and Section 453 to allow for additional tax deferral strategy for our investment clients,” explains Gabrielle Glass, assistant vice president and regional account manager in IPX 1031’s Chicago office.

The structured sale product was created by Allstate Insurance Company in 2005, so it is a relatively new concept. Allstate and John Hancock are two of the companies that now offer the product to investors.

“We’ve discovered a way to bring new product to the process of managing tax liability,” adds Thomas Dunck, IPX 1031’s vice president and regional manager in Chicago. “1031 is still the most favorable section, in that you  can defer all gain, but section 453 gives installment sales treatment some preferred tax treatment by spreading out the gain recognition over a period of time.”

For example: If an investor completed a $1 million sale, and wanted to receive $100,000 per year for the next 10 years, the gain on the transaction is recognized as those $100,000 payments are received over the 10-year period, rather than having it assessed as a tax in the year of the closing of the sale.

One of the downsides of such an installment sale is that there is always a potential default by the buyer of the property. What happens if the buyer is having financial difficulty in year three and cannot make the payment?

What IPX 1031 has been able to do is find a mechanism when implementing installment sales in which the obligore — the individual that is paying the installment payments — is replaced by a Fortune 500 insurance company. With the risk of default essentially eliminated, IPX 1031 can structure the cash piece of a transaction to be received as an annuity, over a time period that fits the financial needs of the client.

IPX 1031 has developed a relationship with a designated partner that is able to broker these structured sales, and the two firms are approved by Allstate and John Hancock, two reputable insurance companies with rock solid credit ratings, to market the structured sale program.

“The structured sale program is a beneficial strategy when the taxpayer is not able to find replacement property, or when an investor is dealing with ineligible assets for 1031 exchanges, such as a substantially appreciated vacation home that exceeds the exclusion.” Dunck says.

Investors utilizing the structured sale program can actually acquire replacement property, such as a TIC interest or oil and gas program, Glass explains. “Then, the investor can use the money left over that would otherwise be boot to enter this annuity program. We’ve mixed these programs together for enhanced diversification.”

For investors with a significant debt piece attached to their transaction, a structured sale may not be ideal.

“You cannot offset the gain recognition of the debt piece of a failed exchange or an ineligible exchange asset,” Dunck explains. “There would be boot recognition on the mortgage that is not being replaced; there is no way to bring financing into this kind of structure. It is not a cure-all — it’s still not as good as a 1031 exchange, but for the appropriate taxpayer, it does offer some real benefits.”

While the structured sale obviously isn’t the perfect investment tool, it provides a valuable opportunity for diversification, which should be every investors aim

Diversifying the Portfolio

Regarding the traditional 1031 exchange market, Dunck and Glass are confident that the problems in the financial sector will not significantly harm their business.

“All of the news [regarding the trouble in the financial sector] does contribute to investor anxiety,” Glass says. “Even so, vacancies and rents are improving, cap rates have stabilized, and the stock market has been hit pretty hard — I think real estate is very strong. Our 1031 business continues to be strong.”

The recent interest rate drops should generate more investor activity, and the conditions should lead to more careful, highly underwritten lending practices from the banks. Investors with significant equity will be best positioned to take advantage of the current market, and now is great time for such players to diversify.

“We see an increasing interest from taxpayers wanting to diversify,” Dunck says. “The oil and gas market is a really different product, but for tax purposes, as a royalty interest, it is deemed to be like-kind or real property”

Many investors have moved from selling fee-simple interest in real property and reinvested, at least partially, in oil and gas programs. The rates of return are typically very attractive, and investors get the tax benefit of depletion, which is on a more accelerated basis than the depreciation available in office or apartment properties. And it is a safe bet that the oil and gas industry is not one that will be going away anytime soon.

“There are limitations to investing in [to oil and gas programs],” Dunck notes. “If you have a highly leveraged property, it may not make sense. It is good for people that want to diversify and may have a lot of equity on their sales side of the transaction.”

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