ROANOKE TIMES
Copyright (c) 1996, Roanoke Times
DATE: Monday, April 29, 1996 TAG: 9604300007
SECTION: MONEY PAGE: 6 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
THE recent transfer of property in a Roanoke suburban office park highlighted an increasingly popular method of property swaps to defer taxes on capital gains in real estate.
And the same rules apply to any investment property - a small storefront or a duplex apartment - as well as to larger commercial complexes.
Jim Hodges of Hall Associates Inc. in Roanoke, who structured the exchange of three buildings in the Colonial Green office park for property in West Virginia, said the idea of trading property has been around for years, but recent changes in the law make it more attractive.
In that deal, reported last week, the local office buildings were acquired by Barton Properties L.L.C. from Roanoke investors Frank Porter and Joe Durrer.
One change, for instance, allows any type of investment property to be swapped for any other type instead of being limited to trades of similar property. Another allows one of the buyers to put up cash instead of being an active participant in the trade.
In theory, a homeowner could use the idea to exchange one house for another. But Hodges said it is more favorable to rely on the law that permits deferment of taxes for people who move to another house of equal or greater value within two years of selling the old one.
No such exemption exists for investment property, however. Hence the growing popularity of arranging a trade. Evidence of the growth in realty trades is the amount of money held by escrow agents while trades are being completed.
C. John Renick, manager of the Roanoke branch of Lawyers Title Insurance Co., said his firm held $233.7 million in escrow accounts at the end of last year. That compared with just $72.6 million at the end of 1994. The word is beginning to get out among the owners of investment property, Renick said.
His firm created Lawyers Title Exchange Co. in 1991 to act as escrow agent for land swaps. Hodges and Renick said it is the only company in Western Virginia that provides such a service.
Lawyers Title began marketing its service only two years ago. Renick said the Roanoke office, which handles business in Western Virginia and in West Virginia, probably had 20 cases in 1995, most of them coming at the end of the year.
The company was involved in the land swap at Colonial Green.
Here's how that deal came about: Hodges said a native Roanoker, who owned a camp resort near Harper's Ferry, W.Va., had two goals. He wanted to retire from active management of a campground in favor of a passive investment that would not call on his energies; and he wished to retire to Roanoke, bringing his investment home with him.
The problem was that he had a huge capital gain on the campground he had managed in West Virginia for so long. Hodges suggested a land swap to save this tax.
The investor sold the land to a campground chain based in Idaho. Hodges said the chain paid cash because it was no longer required to become an active participant in the land swap.
But the cash never came into the investor's hands, where it would have been taxed. The Idaho company paid the money directly to Lawyers Title as escrow agent.
Hodges had only 45 days to find a new investment for the money. The new real estate had to equal (or be costlier than) the money on hand.
He came up with three buildings at Colonial Green, an office park at Electric Road and Colonial Avenue. The deal had to close within six months of the date of the campground sale.
Because the deal was a swap rather than a sale, the tax on the capital gain is deferred - just as it would be for a home.
The investor will pay tax on the capital gain if he sells the office park for cash, although there is no limit on the number of times he can swap.
But, Hodges pointed out, the money will never be taxed if the investor dies holding the property. That's because the tax basis of all property held at death is stepped up to the value at the date of death.
Estate taxes would be due, however. Hodges said the family would merely avoid the double taxation of capital gains and estate taxes.
The old tax basis of the property transfers to the replacement property. The new owner can again write off depreciation against the new tax basis, Hodges said.
Three parties are not required, although that is the usual pattern. Two people can trade properties with or without a cash supplement.
In the past, Hodges said, there was no 45-day lag to put the properties together. All had to be identified and closed at the same time. And the outside buyer, in this case the campground chain, could not put up cash. All properties once had to be traded back and forth. This has now changed to make the trade easier to pull off.
All of this is legal, Hodges said, even if the sole purpose is to save on taxes.
There is a more traditional way to avoid paying taxes on a capital gain, Hodges pointed out. That is for the original owner to finance the purchase, paying taxes only as installments are paid on the loan.
That has some disadvantages. The new owner can trash the property, reducing the value, before the loan is paid off. Or the new owner can simply stop paying, forcing you to foreclose on the property and begin again.
A swap, on the other hand, closes out the deal for good. That makes it especially suitable for people who want to move, such as from Roanoke to retire in Florida, and don't want to leave loose ends behind them.
Swaps have a downside, too: part of the tax savings will be offset by fees to the escrow agent who actually takes title and trades the property. Renick of Lawyers Title said, however, that the fees are negotiable. The money is invested while it is in escrow, Renick said, so the company and owner earn some interest.
Hodges said it is legal to swap a business property or an office building for, as an example, an apartment building. Any commercial or investment property can be exchanged for any other except a property held solely for resale.
And, of course, the process makes no sense for someone who has a loss rather than a gain. It is better to take the loss on tax returns than to shield the sale from tax consequences.
Hodges said the law has allowed people to sell and change their investment. In the past, he said, wealth was often tied up in a property with a large capital gain.
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