Re Academic Press Private Real Estate Investment_7

The Tax Deferred Exchange 185 to justify the cost of an exchange. An interesting empirical study would examine a number of exchanges to determine if perhaps one should not exchange unless one acquires a property at least 1.5 or 2 times the size of the disposed property. Suppose our investor merely retained his original property for the same total time of 12 years. Because he saves mid-holding period sales costs, he has a higher return in both IRR (14.32%) and NPV ($36,314) terms. Note in Figure 7-5 that while the total sales price in the two strategies is greater for the exchange strategy on the left, the owner’s share is greater on the right when no exchange takes place. We see that under these assumptions the primary beneficiary of the exchange is the broker. Several conclusions may be drawn from this. Once again we confirm the fact that pursuing tax objectives for their own sake is counterproductive. Another is that the primary beneficiaries of some exchanges are brokers. Commissions make up the majority of real estate transaction costs. In order to offset these transaction costs, the investor must be able to achieve significant economic gains. There is a limit to the benefits of releveraging via an exchange, and these benefits may not be sufficient to offset transaction costs. DATA ISSUES Data providers sometimes included a binary (Y/N) field to answer the question: Was an exchange involved? This is important when studying Allocation of Sales Proceeds $2,173,505 Loan Balance $1,228,426 Allocation of Sales Proceeds $1,760,814 Loan Balance $760,139 Equity Reversion $684,032 Sale Costs $132,061 CG Tax $153,372 Equity Reversion $715,242 (a) FIGURE 7-5 (b) Allocations with (a) and without (b) exchanging. 186 Private Real Estate Investment markets to determine how tax policy affects investor behavior. However, a refinement is necessary. For this data field to have maximum value, it is important to identify how the exchange fits into the transaction. If the sale involved an exchange in which the seller was the last in a series and did not further exchange his property, there is a different effect than if the seller became an acquiring party an a subsequent exchange. Theoretically, there should be a cumulative effect. The last seller who does not require an exchange may reap benefits from each party lower down in the chain, especially if the 45-day deadline is shorter with each successive transaction. There is no reason this must happen, but it should increase pressure in the system as the number of exchanges in a series grows if the deadline does grow shorter. We leave this interesting study to the game theorists. What we suggest is not a trivial task for data collectors. The result of any such effort would be to track transactions after the closing and tie multiple transactions together. This is not an appetizing assignment, and we do not expect it to be completed soon. Until that is done, we will have to rely on theory to study investor behavior in a tax environment that rewards exchanging over sale and repurchase. CONCLUSION After wading through a blizzard of numbers, sorting out complex sub-calculations dependent on other variables, and running a variety of hypothetical situations, there is one conclusion that is neither a surprise nor in doubt: The investor who adds entrepreneurial labor to increase his rate of return and delays his income tax for a long time is able to build terminal wealth faster. For investors where entrepreneurial issues do not apply and annual returns are moderate, the conclusions are less certain. Given the costs, explicit and implicit, the investor who merely plods along with the rest of the economy must be very careful when undertaking an exchange. Scale factors come into play. The size of the acquired property relative to the disposed property strongly influences whether the cost of an exchange can be justified. In our continuing quest to understand real estate risk, exchanging plays a minor role. There is an analogy to the debate over double taxation of corporate dividends. A double taxation policy encourages borrowing, leading to the additional risks in the securities market. For real estate, a sequential taxation policy incrementally taxes each property in a series as it is sold. This encourages more borrowing either for non-taxable refinance and repurchase strategies that reduce investor efficiency by adding multiple locations or for borrowing to keep ownership levels where they would have been if a tax The Tax Deferred Exchange 187 deferred exchange strategy were available. Either of these, while good news for banks, is not good news for society in general if borrowing is seen as adding unnecessary risk to the system. It has been observed by many that taxes are necessary to operate a civil society. In the debate over which taxes provide the most revenue and do the least harm to the market, it is generally agreed that the best tax is the one that changes behavior the least. Income taxes have a poor record in this regard. Capital gain taxes fare no better. The study of real estate tax deferred exchanges is fertile ground for watching the contortions of investors bent on reducing their tax obligation. A final note for policymakers may be in order. Sections 1034 (applying to single family residences) and 1033 (applying to property subject to invol-untary conversion such as condemnation or casualty loss) provide different sets of rules for the sale and reacquisition of property without the payment of taxes. There may be merit in the simplification of these various sections into a single set of rules that acknowledges the benefits to society that accrue from allowing land to remain untaxed in entrepreneurial and productive hands for as long as possible. For those countries in the beginning stages of formulating tax policy, the clean slate they start with might first recognize the perverse incentives in the U.S. tax code as written and avoid expensive pitfalls. If there is one conclusion that remains it is the idea that entrepreneurial effort adds value not only to the investor’s terminal wealth, but to society’s built environment. The preservation of the nation’s housing stock and the optimization of its commercial facilities depend on the wide dispersal of ownership among the most qualified investors. Keeping those assets in capable hands for as long as possible would seem to benefit society the most. REFERENCES 1. Allen, M. (1990). Creative Real Estate Exchange: a Guide to Win-Win Strategies. Chicago, IL: National Association of REALTORS. 2. Internal Revenue Service. IRS Revenue Ruling 72-456. 26 CFR 1.1031(d)-1. 3. Sherrod, J. R. and Diggs, J. B. Merchantile Trust Company of Baltimore and Alexander C. Nelson, Trustees of the Estate of Charles D. Fisher v. Commissioner of Internal Revenue. Merchantile Trust Company v. IRS, Docket # 68338. 4. Tappan Jr., W. T. (1989). Real Estate Exchange and Acquisition Techniques (2nd ed.). Englewood Cliffs, NJ: Prentice Hall. C H A P T E R 8 The Management Problem ...all that can be required of a trustee is that he conduct himself faithfully and exercise sound discretion and observe how men of prudence, discretion and intelligence manage their own affairs—not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income as well as the probable safety of the capital to be invested. The Supreme Court of Massachusetts in Harvard College versus Amory (1830) articulating the Prudent Man Rule INTRODUCTION This chapter addresses what is known as ‘‘the agency problem,’’ recognizing that when an agent holds someone else’s capital the agent’s objectives are often different from the owner’s. In this chapter we will: Describe the optimization problem that faces any manager of properties in multiple locations. Describe the owner’s problem, showing how his objectives differ from the manager’s. Illustrate the misalignment of incentives and compensation arrange-ments common to the business of managing small investment properties. THE UNAVOIDABLE MANAGEMENT ISSUE There is little debate that the ownership of real estate involves management. The debate is about (1) who shall do the management, (2) what manage-ment costs, (3) how one accounts for that cost, and (4) what management arrangement is the most efficient. We observe that some owner’s do their own 189 ... - tailieumienphi.vn