A Like-Kind Exchange
(LKE) program, also known as a Section 1031 Exchange, allows the
tax owner of an asset to defer any associated gains (and therefore
tax) on the sale of that asset when the proceeds of the sale are
used to purchase a replacement asset.
Historically, the labor involved in managing a repetitive LKE process
on lower-value assets was simply not economical, given the document-intensive
nature of recording numerous transactions and depreciation schedules.
Today, with an effectively managed, technology-based LKE service,
lessors of all sizes are able to increase cash flow more quickly,
thereby dramatically improving their base yields.
To understand the benefit of including Like-Kind Exchanges in a
true tax lease, it is best to review two different
leases: One that reviews the yield of a lease that includes depreciation
but not LKE, and one that includes depreciation as well as LKE
benefit. For this analysis, the following lease assumptions will
be common:
Combining elements from the lessor's Federal Tax and Cash Flow
Statements, the following table is generated.
Further, analysis of the associated monthly cash flows indicates
that this particular lease results in a pre-tax Base Yield of 7.99,
representing a Yield Spread of 3.24 over the lessor's Cost of Funds
of 4.75.
*Includes initial lease funding of $ 1,000,000 in
year one and residual realization of $150,000 in year six
Assuming an early buyout of the original asset after the third
year, and that the lessor utilizes "Step-in-the-Shoes" depreciation
for the replacement asset, the following taxes and cash flows
would apply on the lease for the replacement (purchased) asset.
*Includes initial lease funding of $1,000,000 in
year one and residual realization of $150,000 in year six
**"Step-in-the-Shoes" Depreciation Utilized
Performing the same analysis on the replacement lease's monthly
cash flows indicates that the Base Yield has increased from 7.99
to 8.81; a Yield Spread increase of 82 bps.
Where does this 82 bps increase come from? There are two elements
that combine to accelerate cash flows (thereby increasing pre-tax
Base Yield) in this transaction. The first element is the Deferred
Tax Adjustment of $74,200 recognized in year 1 of the replacement
asset which is a self-explanatory output of the LKE program.
The second component to these accelerated cash flows lies in the
utilization of "Step-in-the-Shoes" depreciation. In effect, "Step-in-the-Shoes"
is a method for continuing the original asset's depreciation schedule
in an accelerated manner.
Every portfolio is slightly different, and each Like-Kind Exchange
program should be tailored to meet these individual needs. To calculate
the base yield improvement your portfolio will achieve through
a Like-Kind Exchange program, please contact Accruit at info@accruit.com
or 877.793.9215.
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