Tony,
I apologize for not making my point; 1031 Exchanging as a long term systematic real estate wealth building strategy and lifetime income generator is the goal. Not for someone to sit on properties for decades.
One of the biggest misconceptions I witness time and time again with investors is regarding their ROE (Return On Equity).
For example, if you acquired one of your SFH for $100,000 and paid all cash (Mortgage Free) and we subtracted your expenses at $2,000 from gross rents of $12,000, you would have a NOI of $10,000. Your ROE is $10,000/$100,000 or 10% ($10,000 net income divided by your $100,000 equity). It's like a $10,000 Bank CD paying 10%.
But, let's move forward 15-years where that same SFH is now worth $175,000 and mortgage free. You now have $175,000 equity. Using the same ROE formula we get $10,000/$175,000 ROE = 5.7%.
Yes, rents will go up, say 50% for $18,000 annually. So will your expenses, say 25%, e.g. $2,500. Your new NOI of $15,500 ($18,000 rents minus expenses of $2,500) or $15,500/$175,000 result in a ROE of 8.8%. Your ROE can decline the longer you hold the property.
What's more dramatic is the following:
By holding your SFH you earn:
1. $100,000 FMV at 3.9% Appreciation annually.
2. $100,000 FMV less land value with annual Depreciation/27.5 years. (could eventually cease)
3. No Mortgage = No Mortgage Reduction paid by Tenants
4. Rents based on a $100,000 Property appreciating at 3.9% annually (historical).
However, if you systematically 1031 Exchanged every 5 -7 years you would have:
1. Systematic Increases in FMV because of 3.9% Appreciation annually.
2. Systematic 3.9% Appreciation annually by 1031 Exchanging Up to 25% - 50% FMV Increase.
3. Depreciation increase annually/27.5 years. Always have depreciation because of new properties.
4. Mortgage Reduction paid by Tenants (suggest 15-year fully amortized loans).
5. Increase in Rents because FMV of property is more, eventually much more.
Also, #3 and #4 will help offset your taxable rental income.
I call this scenario the "Fitness Gym Dynamic". You have a friend who wants to be a body builder but year after year he/she uses the same dumbbell weights, choosing to never increase them because they are ... "comfortable".
The Rich have long known about and utilized 1031 Exchanging as a very effective real estate wealth building strategy and lifetime income producing Tax Tool.
I will conclude with a quote from a famous American Judge, Learned hand.
"In America there are two tax systems, one for the informed and one for the uninformed. Both systems are legal".
Good luck to you.
Thomas,
How have you personally used and benefited from using the 1031 with your own properties?
