If you own commercial property of any kind, whether it’s where you operate your business or it’s property you lease to others, this program is for you. The IRS tax code includes provisions that could save you money — potentially a lot of money. However, many business owners are not aware of these advantages that have actually been part of the tax code for years, so we’ve invited Mr. Steven Oppenheim to fill you in on the details. He’s a CPA and partner at Gettry Marcus in New York. As a member of the firm’s Real Estate Group, he works with commercial and residential property owners and developers on matters that may impact their businesses.
The rules are very, very broad, and it's in the tax payer's favor in terms of going from one type of property to another and still being able to get a 1031 deal done.
- Steven Oppenheim
Jeff: Do you own the commercial property your business occupies or other commercial property and you're thinking about selling it? If you're interested in saving potentially a lot of money after you sell it, you've come to the right place.
From our studio in Southern California, with guest experts from across the country and around the world, this is “Deal Talk,” brought to you by Morgan & Westfield, a nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.
Jeff: Hello and welcome to the web's number one content source for small business owners committed to building a business for eventual sale. Here on “Deal Talk” it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
If you own commercial property of any kind, whether it's where you do business or its property that you lease to others, this program is definitely for you. Our guest is Mr. Steven Oppenheim, a CPA, and partner at Gettry Marcus in New York. As a member of the firm's real estate group, he advises both commercial and residential owners and developers on matters that may impact their businesses. Steven Oppenheim, welcome to “Deal Talk.”
Steven: Thank you. Nice to speak to you, Jeff.
The good thing is, there is an exception to this general rule under internal revenue code section 1031, which if properly structured allows the taxpayer to sell real estate property, reinvest the proceeds in a replacement property and defer paying taxes on the gain.
Jeff: Steven, tell us a little bit about what you do over at Gettry Marcus.
Steven: Sure. I am a partner at Gettry Marcus where I am the partner in charge of the real estate group. I am a certified public accountant with 22 years of public accounting experience. Gettry Marcus is approximately an 80-person CPA firm in the New York metropolitan area. We are a top 200 firm nationally with offices in New York City and Woodbury, New York. Our firm provides accounting, tax and consulting services in various industries, which include real estate, healthcare, manufacturing, business valuation and forensic accounting. I specialize in the areas of real estate and high net worth individuals. Our real estate group provides a variety of accounting, tax and consulting services to owners, operators, developers and real estate managers. We also specialize in structuring transactions including 1031 tax deferred exchanges, and complex partnership entities.
Jeff: Very good, Steve. I appreciate that. What we want to do today is for those folks listening who are property owners or interested in owning property in generating income by leasing property out. This is kind of the show for you. And I'd like you to consider this a different kind of a “Deal Talk” experience here, more of a workshop. This is an opportunity for you to really learn from someone who specializes in this area, so let's get right down into it. Steve, just kind of setting up a scenario here, if I was looking to go into the real estate business as a landlord, it seems to me like this is probably … and it's just me talking here ... it seems that this is really an ideal time to be a commercial property owner. And I had designs on leasing this property out to other business owners. If I find a rental property that I'm interested in purchasing for the purpose of renting out, should I negotiate the deal for that property for myself, or would I be better off working with someone to help?
Steven: OK. I think it would be very important to put a team of professionals together to help protect your investment. Remember, you're investing a lot of money; you always want to protect that investment. This team should include a real estate agent. An agent is vital in educating you about a specific geographical market, and it could be a very good resource in helping you find a property that fits your situation. Obviously, there are all kinds of properties out there; you’ve got to find one that’s tailored to your situation and what you're trying to accomplish. They will also act as the liaison between you as a buyer and the seller, and will help you negotiate in getting the deal done. Obviously, it is important to work with a broker you trust and who is well experienced in that particular marketplace. Another team member I would add would a good attorney. It's very imperative to work with a knowledgeable attorney to help protect your investment. The attorney will assist you in drawing up all the contracts and work with the title companies that verify there are no issues with ownership and there are no restrictions that will affect your proposed use of the property. Another very important task would be for the attorney to review existing tenant leases, so you as the landlord know exactly what your obligations are for the remainder of the tenant leases. Another good person to add to that team would a CPA. And I think hiring a competent accountant can be extremely useful in helping you figure out how much you can afford to pay to acquire the real estate. They could assist you in the preparation of budgets, cash flow projections, expected return on investment and also perform tax projections taking into account the appreciation deductions. The accountant can also assist in structuring the transaction, including choosing the type of entity to use to acquire the property. And that will be tax efficient and minimize liability.
I think one other recommendation I would have is to go speak to a mortgage broker or a bank directly to start the process of negotiating with the banks in advance of purchasing a property so you could weigh all your financing options. For example, what your borrowing restrictions are and how much cash you will need to come up with to acquire the prospective property. And maybe just some other professionals that you would want to hire as well would include an engineer and consultant to prepare environmental studies so you know exactly what you're getting into, because, again, it's going to be probably a large investment. It's a business you're going into and you just want to make sure that your investment is protected to the best extent possible.
Jeff: What a team indeed. We already talked about, essentially, there about five people: real estate agent working with an attorney, a CPA, banker perhaps, and an engineer possibly. And an engineer would really be handy particularly for those older properties I would think, or where you have special needs perhaps if you've got a manufacturing company. And you have an interest in leasing, too, perhaps, or maybe even your own manufacturing company for that matter, so there are a lot of things to think about. Steve, any thoughts that you might have about which one of those individuals you should probably be in touch with first? I'm probably thinking attorney for me, but I'm wondering if you have thoughts on that and if maybe it might be different for different folks.
Steven: It might be the real estate agent to start with, and just kind of seeing what's out there in terms of whether the business plan is feasible and there are properties out there that fit what your needs are. So I would say the real estate agent might be first. And then shortly thereafter would be contacting an attorney, because the attorney should be involved in the entire process.
Remember, you're investing a lot of money; you always want to protect that investment.
Jeff: Many times we see as we're driving by an industrial center for example, and there are a lot of those where I sit here in Southern California, a lot of distribution, warehouse facilities out here. Is it always necessary, do you think, Steve, to contact the people there on those signs in front of those buildings? Or if I've got a reliable source of information perhaps from a professional in my own network of professionals that know somebody in the commercial real estate business. Can somebody who may not necessarily be named on that sign help me out in negotiating the terms for that property, someone that I can hand-select, if you will?
Steven: That's a great question. And I'll tell you why. If you contact a person on that sign, their goal from the very start is to act as a representative on behalf of the seller and just get a deal done so they could get their commission. So I think it's very important. What you would be looking for is on the buyer side. There are real estate brokers you could hire independently to act as your representative as the buyer and not have a conflict of interest, so I think that's a great question and that's very important. Because, as I've stated, it's very important to find a broker that you trust and who's well-experienced in the marketplace and to avoid having that conflict of interest.
Jeff: You're talking about saving potentially not just thousands of dollars but perhaps tens or even hundreds of thousands of dollars perhaps in some of the larger cases. If I was looking to sell my property, maybe I’d like to reinvest the proceeds in new property someplace else across the country or any place else, are there any significant tax planning tools that I can use to help defer paying taxes so that I'd have more capital that I can invest in the acquisition of new rental property, for example?
Steven: The general rule is whenever you sell real estate property at a gain you generally need to pay taxes on the gain at the time of sale. If the landlord is looking to upgrade in properties or is looking to move to a different geographical location, then having to pay a big tax on a gain would reduce substantially the amount of capital you have available to reinvest in the new property. The good thing is there is an exception to this general rule under internal revenue code section 1031, which if properly structured, allows the taxpayer to sell real estate property, reinvest the proceeds in a replacement property, and defer paying taxes on the gain. The code states no gain or law shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind property. I'll just brief you on the 1031 rules. The general rules to qualify for a 1031 exchange are as follows. The form of transaction is a sale or an exchange. Both the property transferred and the property received are held either for productive use in a trade or business or for investment. And the property transferred and received is like-kind property. In this case, like-kind was intended to be interpreted broadly. For example, you can exchange commercial property for residential rental property. You could exchange residential rental property for industrial property. The rules there are very broad.
If you contact a person on that sign, their goal from the very start is to act as a representative on behalf of the seller and just get a deal done so they could get their commission.
Jeff: Who is the best person in that team that we talked about earlier to help me determine what truly is like-kind? If I know that that's what I have to look for and I'm out there on the prowl, I'm looking for my next investment to make in talking about like-kind property investment, who's going to be able to help me determine what like-kind actually is and what would qualify?
Steven: There is a team out there that you would need to put together because an exchange would have to be done through something called a “qualified exchange intermediary.” They must be used to execute the transfers of the buy and the sell of the property and ensure that all regulations are followed. It's also imperative that you use a well-experienced tax professional to assist you in the transaction. And between those two parties and the attorney as well, they would kind of lead you in the right way of what would be considered like-kind property. But as I said, the rules are very, very broad, and it's in the tax payer's favor in terms of going from one type of property to another and still being able to get a 1031 deal done.
Jeff: Talking with Steven Oppenheim. Steve is with Gettry Marcus. He's in the firm's real estate trust and estates group and a partner at the firm, and we're going to continue our conversation when “Deal Talk” resumes after this.
If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on a future edition of “Deal Talk.” Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, an area of specialty and contact information, and send it to firstname.lastname@example.org, that's email@example.com.
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Jeff: Welcome back to “Deal Talk,” where we're becoming the Internet's go-to resource to help business owners understand what it takes to sell their company successfully. You can find a wealth of resources along with all “Deal Talk” episodes and their transcripts simply by visiting morganandwestfield.com. You can also listen to this show on iTunes. Just look for “Morgan & Westfield Deal Talk” in the search function.
My name is Jeff Allen. I'm with Steven Oppenheim today. He's a CPA and a partner at Gettry Marcus in New York. Steve, we were talking a little bit about tax planning tools to help defer paying taxes so that it’d have more capital to invest in the acquisition of new rental property later on. And you were just starting to get into the actual ways or means by which we can, in fact, defer those taxes, what is needed. So let's go ahead and continue our conversation from that point.
Steven: OK, great. We've just spoke kind of about the general rules to qualify for a 1031 exchange, and now let's talk about … in order to obtain a deferral of the entire capital gain tax, the taxpayer must do the following: Purchase property of equal or greater value. Obtain equal or greater financing on the replacement property that was paid off on the relinquished property. All the net proceeds from the relinquished property need to be reinvested in the replacement property, and a taxpayer could receive nothing in exchange but like-kind property. So if the exempted taxpayer receives any cash from this transaction, that portion would be taxable. Also, there are two primary requirements in getting a 1031 exchange done. There's a 45-day rule and an 180-day rule. The 45-day rule is where the taxpayer must identify the replacement property within 45 days of when the relinquished property is transferred. And the 180-day rule is where the taxpayer must acquire the replacement property within 180 days of when the relinquished property is transferred. Or this must be done by the due date of the tax return, including extensions if that is sooner. So as you can see, although it's a great vehicle to use, there are complications and there are very stringent rules that need to be followed here. So it is very important to have a qualified exchange intermediary help you execute the transfers, and a tax professional to help assist with the transaction, as well as your attorney.
Jeff: Boy, that's for sure.
Steven: Maybe just to bring all this home, I think I would like to use an example to kind of help the audience get a better understanding if that's OK?
You would defer paying a million dollars in tax and have the ability to use these funds as capital to fund the purchase of the replacement property.
Jeff: No, that's perfect. It'll really help to kind of highlight the key points and really, like you said, kind of drive the point home.
Steven: OK. Let's say the facts are as follows. You own a rental property with 10 tenants and you are looking to upgrade to a property with 30 tenants. The selling price of the building you currently own is $5 million, which has a mortgage of $2 million. Let's say there's a gain on the sale of the property of $3 million, and let's say the tax on that gain if you did not do a 1031 exchange would be $1 million dollars. And let's say the purchase price of the replacement property is $10 million and you will use net proceeds of $3 million from the sale of the existing property as a down payment and take out a mortgage of $7 million. This would be, in my opinion, a perfect fact pattern into entering to a 1031 exchange and defer paying any taxes until the replacement property is sold. Since in our fact pattern and you would be invested in the entire net proceeds from the sale of the property and like-kind property, and you are replacing debt on replacement property and excess of debt on relinquished property, you would defer paying a million dollars in tax and have the ability to use these funds as capital to fund the purchase of the replacement property. As you can see, this would be a great vehicle to use for someone looking to reinvest their proceeds in real estate. As stated earlier, I strongly recommend, though, you use a well-experienced, qualified exchange intermediary, a good attorney and a tax professional to assist in structuring this transaction.
Jeff: Steve, let me ask you really quick, and I don't want to sound like all of a sudden I stopped paying attention because I want to make that perfectly clear. There are a lot of details here in this discussion, and we talked about the importance of forming a team and using that intermediary you're talking about is going to be able to help fill in the blanks. But I want to make it clear, we started the top of the show, we were talking about if it is your business, if you are in the business of owning commercial property and leasing that property, that's where we started. Is this the kind of thing that a business owner of another type of business, maybe he is not a professional property per se. He's not a landlord but he owns his own property, or she owns her own property for their business. It could be for any kind of industry. Is this something that they would also be able to take advantage of, too, that they don't necessarily have to lease space out in their building to other tenants, but in fact they just use their building for their business only. Can they also take advantage of the 1031 exchange program?
Steven: Absolutely. And I think it's a very, very key tax planning tool because, let's just say, for example, you're a manufacturer and you own your own building. Normally the way it would be structured is the real estate would be held by one entity and the manufacturing operations would be set up under a different entity, but you're dealing with the same situation. Now you're in a situation where maybe you have to move to a bigger space, you outgrew your old space, and let's just say you bought the real estate a long time ago and you have very little basis in the real estate and you would wind up having to pay tax on a very large gain just because the market has increased dramatically over the years. This would be a perfect tool to use to reinvest those proceeds in a new and bigger space, and being able to defer paying taxes on the transaction.
Jeff: We're all about, Steve, helping business owners, regardless of what area of business they're in, save money, and improve the value of their companies in the process. And I think that that was a very important point we had to discuss on that. And something else that I think is really important, and this will kind of, I think, round out our discussion on this edition of “Deal Talk” today.
Determining whether or not the improvement that one requires for their property, should they be capitalized or expensed? How do we determine which one of those we need to do and have there been any important updates in this area to help us determine where we're going to get the greatest savings for this? Let's talk about that.
Steven: Sure. This is an area of the tax law that has always been very subjective. But just recently after nearly 10 years in the works, the IRS finalized its tangible property regulations. And these regulations are effective for all years beginning on January 1, 2014. The new regulations for many taxpayers may result in increased deductions than the prior rules allowed. The regulations cover a lot of material and are very complex, so I'll just kind of touch on them here.
If you have a CPA, particularly one who has extensive knowledge of real estate property and all the tax regulations concerning improvements of those types of things, you're going to be ahead of the game and you're going to be serving yourself well.
Steven: The facts and circumstances still play a very large role in determining whether expenditures are deductible or must be capitalized, but these rules were set up to help clarify what items should be capitalized versus what should be expensed. That was the purpose of the IRS coming out with these new regulations. The new concept described in the regulations is a concept of a unit of property, which is one of the most important revisions contained in the regulations. The unit of property as it relates to real estate is broken down into nine categories as follows. It's the building and structural components, the HVAC system, the plumbing system, the electrical system, escalators, elevators, fire protection and alarm systems, security system, and a gas distribution system. And it's important that I mention those because that's really what the IRS is looking to do, is really break down these expenditures into what the unit of property is. Under the new regulations, capitalization is required if the amount paid results in a betterment, adaptation or restoration of the unit or property. If the amounts paid do not meet these conditions, then it is deemed to be a repair and currently deductible.
As these rules are very complicated, the best way to get an understanding of these new regulations is to discuss specific examples provided in the regulations. So let's take a roof, for example. I'm going to give you two different roof scenarios. And what the regulations are pushing taxpayers how to treat it. So you have the replacement of one membrane with a new membrane is not considered a betterment and is, therefore, a deductible. Basically, the roof is made up of different components. You've got the decking, you've got the membrane on top of the decking, and then you might have some finishes on top of that. Here they're talking about replacing the membrane would not be considered a betterment and is, therefore, a deductible. The reason being is that the replacement of the membrane is not a material edition to the unit of property, which is the building structure itself. As opposed to the replacement of an entire roof, which would include the decking, insulation, and asphalt. That would be considered a restoration because a new roof is a major component of the building structure that performs a discrete and critical function. And it is a substantial structural part of the unit or property.
One other example is the replacement of one elevator in an office building that has four total elevators. That was considered not a restoration since one of four elevators does not comprise a significant portion of the elevator system, which is a unit or property in this case. Just to kind of drill it home a little, because I know the rules are complicated, in the past if there were four elevators in a building and you did work on one and totally improve the entire cab of the elevator and really improved it. In the past, you would always have to capitalize, and now you have to look at its one of four and a unit of property is the elevator system as a whole. And therefore, since this is not a significant portion of an entire system, you now have the ability to expense it.
Jeff: Repairs essentially are deductible but improvements or restorations require capitalization or need to be capitalized, correct?
Steven: That's correct.
Jeff: OK, very good. And you really need to have a tax expert who is up to speed on these changes and help you to determine which one of those you're able to take advantage of or which one of those you need to be able to do whether you take the deduction on the repair or you have to capitalize an improvement or restoration, whatever the IRS might consider an improvement or restoration. And if you have a CPA, particularly one who has extensive knowledge of real estate property and all the tax regulations concerning improvements of those types of things, you're going to be ahead of the game and you're going to be serving yourself well.
Steven Oppenheim, this has been a tremendous conversation and really something I consider more of a workshop when you get right down to it, with all of the important information that you've provided in a very comprehensive way as well. Final takeaways here from our discussion if you could. If you were taking an elevator, maybe, in your city to the 50th floor and you are taking a meeting with someone but you had only maybe about 30 or 45 seconds to share some final thoughts before you jump off that elevator, and they were perhaps a landlord or looking at purchasing property, what would you tell them?
Steven: I think again, the keys are putting a team in place that will help you protect your investment. Although it might be more costly upfront, in the long run, it will help protect your investment. In addition to that, there're some great tax vehicles out there. If you are going to reinvest and stay in the real estate market, and continue a trade or business, as a property who's renting either commercial space or residential to tenants, there are vehicles out there to help defer taxes and put your capital to work. And the third item would be some of these rules in terms of capitalization versus repair are more complicated than ever and a good tax professional is very important to have on your side.
I think, again, the keys are putting a team in place that will help you protect your investment. Although it might be more costly upfront, in the long run it will help protect your investment.
Jeff: No doubt before you jump off that elevator they've already got their iPhone or their android out and they're getting ready to take your contact information. How can our listeners, Steve, reach out to you for questions with regard to their own particular situation should they like to perhaps sit down with you to take a meeting?
Steven: I would say the best way is you can go to our website to learn more about myself and the firm, and that's at www.gettrymarcus.com. And the best way to reach me is by email at firstname.lastname@example.org.
Jeff: Steve, I want to thank you so much for taking the time out of your schedule today to share your expertise.
Steven: Thank you.
Jeff: Steven Oppenheim, CPA, and partner at Gettry Marcus, has been my guest. We hope you enjoyed the discussion. I know that I did. To listen to more “Deal Talk,” visit morganandwestfield.com and click on the podcast link at the top of this site.
“Deal Talk” is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Find out how Morgan & Westfield can help you at morganandwestfield.com. For everyone at “Deal Talk,” I'm Jeff Allen. Thank you so much for listening. We'll talk to you again soon.
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