Welcome back old friend! Yes, we have seen a re-emergence of theblessed 1031 tax-deferred exchange in recent weeks, and what awelcome sight it is.

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The opportunity to protect hard earned equity in the sale of aninvestment has been available to investors since 1921. However,this part of the tax code was so complex that only a small segmentof the investment community took advantage of this mechanism.

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In 1990, the Omnibus Budget Act provided more widespread accessto a broader set of investors as this option was clarified andsimplified. Section 1031 exchanges are often mischaracterized as"tax free" when they are actually "tax deferred".

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The theory behind this mechanism is that when a property ownerhas reinvested the sale proceeds into another property, theeconomic gain has not been realized in a way that generates fundsto pay taxes. Only the form of investment has changed, therefore,it would be unfair to collect a tax on a "paper" gain.

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When an investor utilizes this mechanism, the deferred gain ispayable when the replacement property is sold and is not part ofyet another exchange. At that point, the original deferred gain,plus any additional gain realized since the purchase of thereplacement property, is subject to tax.

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1031 exchanges in the investment property market have beengrowing in popularity since the mid-90s and fueled a majority oftransactions in the mid to late 2000s. With falling property valuesand transaction volumes beginning in late 2007, we saw asignificant reduction in 1031 transactions.

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In previous StreetWise columns, I have gone into detail aboutthe supply / demand imbalance and the fact that the volume of saleswas so low due, mainly, to lack of supply as opposed to waningdemand. The supply of available properties for sale is generallyfed by discretionary sellers. When value falls, as it has donesince 2007, discretionary sellers withdraw from the market and thesupply is then fed by distressed sellers. Distressed sellers havenot fed the supply in numbers which were expected becauseeverything that has occurred from a regulatory perspective hasallowed these sellers to avoid dealing with their distressedassets.

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Recently, we have seen the flow of distressed assets begin toloosen as banks and special servicers are beginning to clean uptheir balance sheets and portfolios. Simultaneously, we have seendiscretionary sellers returning to the market. The tangibleevidence that this is actually happening can be seen in the 1031activity we have seen recently. Distressed sellers are rarely leftwith any equity to reinvest in the form of a 1031 exchange.Discretionary sellers, on the other hand, often have significantequity to redeploy via this tax-deferred vehicle. We are, onceagain, seeing sellers ask for flexibility in closing periods toprovide them with better chances of being able to effectuate anexchange.

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During the past 4 weeks alone, we have signed 12 contracts withpurchasers who are investing 1031 funds. Moreover, we are receivingmultiple calls each day from investors who are looking forproperties to complete exchange transactions. This is certainlyreminiscent of 2006 and 2007 when so many transactions weremotivated by tax-deferment. The demand side has been very strongfor quite a while as institutional capital has returned to themarket, joining the high-net-worth individuals and families whichhave dominated the horizon for the past couple of years. Foreignhigh-net-worth investors are present in rapidly growing numbers andthe re-emergence of 1031 capital adds more pressure to alreadyoverwhelming demand for investment properties.

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Don't mistake my perspective as I am not suggesting that marketconditions are back to the go-go, bubble inflating, years of 2005to 2007. I am, merely, passing along a trend that we are seeingwhich has, for the most part, been absent for quite a while. It isyet another sign that the recovery is upon us.

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From an intermediary's point of view, or anyone's, who isreliant upon transaction volume for their livelihood, it ispositive to see this type of activity returning to the market. Tothe extent that distressed sellers continue to dispose of assetsand discretionary sellers return to the market, transaction volumehas no choice but to increase. As sellers with real equity sell,each transaction is likely to stimulate another transaction as a1031 is contemplated.

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This trend certainly bodes well for our projection thattransaction volume will increase by about 40% this year over lastyear. Welcome back old friend, indeed!

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Mr. Knakal is the Chairman and Founding Partner of MasseyKnakal Realty Services in New York City and has brokered the saleof over 1,050 properties in his career having a market value inexcess of $6.2 billion.

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