## Net Present Value

### (Net Present Value) Discussion and Tips

In real estate the best way to evaluate an investment is to net present value model the investment considering all factors including taxes & fees, which can become a bit of alchemy, in projecting future new & changing tax, interest & inflation rates & assuring it all calculates.

In finance, the net present value (NPV) or net present worth (NPW) is defined as the sum of the present values (PVs) of incoming and outgoing cash flows over a period of time. Incoming and outgoing cash flows can also be described as benefit and cost cash flows, respectively.

Time value of money dictates that time has an impact on the value of cash flows. In other words, a lender may give you 99 dollars for the promise of receiving \$103 a month from now, but the promise to receive that same dollars 20 years in the future would be worth much less today to that same person (lender), even if the likelihood of payback in both cases was equally certain. This decrease in the current value of future cash flows is based on the market dictated rate of return and other factors like inflation, market factor & currency buying power.

Cash flows of nominal equal value over a time series result in different effective value cash flows that makes future cash flows less valuable over time. If for example there exists a time series of identical cash flows, the cash flow in the present is the most valuable, with each future cash flow becoming less valuable than the previous cash flow. A cash flow today is more valuable than an identical cash flow in the future because a present flow can be invested immediately and begin earning returns, while a future flow cannot and because the buying power of the American dollars has historically been losing value over time.

Net present value (NPV) is determined by calculating the costs (negative cash flows) and benefits (positive cash flows) for each period of an investment. The period is typically one year, but could be measured in quarter-years, half-years or months. After the cash flow for each period is calculated, the present value (PV) of each one is achieved by discounting its future value (see Formula) at a periodic rate of return (the rate of return dictated by the market). NPV is the sum of all the discounted future cash flows. Because of its simplicity, NPV is a useful tool to determine whether a project or investment will result in a net profit or a loss. A positive NPV results in profit, while a negative NPV results in a loss. The NPV measures the excess or shortfall of cash flows, in present value terms, above the cost of funds. In a theoretical situation of unlimited capital budgeting a company should pursue every investment with a positive NPV. However, in practical terms an investor’s capital constraints and risk sensitivity limit investments to projects with the highest NPV whose cost cash flows, or initial cash investment, do not exceed the available investment capital. NPV is a central tool in discounted cash flow (DCF) analysis and is a standard method for using the time value of money to appraise long-term projects. It is widely used throughout economics, finance, and accounting.

NPV can be described as the “difference amount” between the sums of discounted cash inflows and cash outflows. It compares the present value of money today to the present value of money in the future, taking inflation and returns into account.

REAL ESTATE TIP #1, if you are the selling owner of real estate property do evaluate the impact of expenses & taxes on you and your transaction and do consider your exchange transaction opportunities; 1031 or other, if any.

REAL ESTATE TIP #2, If your buying real estate assure you have a positive net present value.

## Example Purchase & Sale Transaction with Joe and Jane :-)

If you own & are considering multifamily or retail selling income
property in the Northwestern US; and you are in a situation similar
to Joe & Jane Multi-family, you should carefully consider the
following sample tax & cost analysis & getting an alternate plan,
which might include doing a sophisticated exchange deal involving
a JimGorman456 entity. Joe & Jane bought their property in 1985 as
an investment, they now want to retire and/or cash-out. They
remodeled once and re-roofed once.

Joe and Jane really need to consider what they want to do, with or without a Realtor, Financial Adviser, CPA, or Attorney.

• Sell under a typical Purchase and Sale (P&S) for \$800,000 scenario. Paying over \$250,000 (One Quarter of a Million dollars in Taxes & Expenses. – No Es Bueno !!)
• Do a 1031 Exchange; with or without taking boot out, which trap all or part of their equity or cash.
• Exchange into a business relationship that will allow them to borrow; up to the cash to Seller after taxes and expenses from a purchase and sale; and become a shareholder partner in the entity exchanged into. Thus, benefiting by having spendable cash and some additional benefit from the “Tax Trapped Equity.”

Phone Jim Gorman IV at (253) 853-1408, if your interested in a no obligation discussion of your options and willing to share data on what your considering.

## IRS Rules & Regulations of a 1031 Exchange | Call 253-853-1408

You must not have any access to the money from the sale of your property. The easiest and most effective way to accomplish this is by using a (QI) qualified intermediary. You will sell your existing property and the money will go to the intermediary who will hold the funds in an escrow account. When you purchase your replacement (new) property, the QI will deliver the funds to the closing agent and the new property will be deeded over to you. The intermediary’s fee will vary depending on location and the number of properties involved, but they will generally charge

TIP: While using a QI is not mandatory to complete a deferred exchange,   it is strongly recommended. Without one, you have to meet one of the IRS’ complicated safe harbor requirements to successfully complete your exchange.

1. You must reinvest all of the proceeds from the sale of your property into the new property. If you do not, you will have to recognize a capital gain based on the amount of money not reinvested.

2. Once you sell your existing property, you have 45 days to identify a replacement property. You may identify more than one replacement property, but if you do, you must comply with one of the following three rules:

Property Rule – You may identify up to three replacement properties without regards to their value; OR 200% Rule – You may identify as many properties as you want as long as the total value of all the properties does not exceed twice the value of the property you are relinquishing; OR 95% Rule – You may identify as many properties as you want but the property (or properties) you eventually buy must have a value equal to at least 95% of all of the properties you identified. For example, if you identify five properties worth \$1 million collectively, the property you end up buying must have a value of at least \$950,000.

3. The replacement property must be of equal or greater value to the property you are relinquishing. You must trade up in value or you will end up recognizing a capital gain for the decrease in value between your old property and new property.

TIP: Since you will have fees involved in selling your property, such as brokers’ fees, intermediary fees and other closing costs, the purchase price of the replacement property should be equal to or greater than the total debt on the property you relinquish plus the net amount of money you receive from the sale of your property.
In addition, the debt on the new property must be greater than the debt on the old property or the amount of equity in the new property must be greater than the equity in the old property. However, as long as you are trading up in property value and you invest all of the proceeds being held by the intermediary into the new property, the debt/equity requirement will take care of itself. That is because either the debt will be higher due to the higher purchase price of the new property or you will have to invest your own money (equity) in the new property to make up the difference.

4. Once you sell your existing property, you must close on your new property within the earlier of 180 days or the due date of your tax return (including extensions). It is important to remember that the 45 day identification period runs concurrently with the 180 day closing period.
Example: You sell your property on June 1st. You have until July 15th (45 days from June 1st) to identify your replacement property and you must close on the replacement property by November 27th (180 days from June 1st).

TIP: If you enter into a deferred 1031 exchange and sell your property between October 1st and December 31st, be sure to file an extension for your individual tax return due on the following April 15th. Otherwise, your window to close on the new property may be reduced by as much as 2 1/2 months.

5. The QI will contact the closing agent, complete the necessary exchange paperwork and transfer the funds to escrow for the purchase of your replacement property.

6. When you file your tax return, you must report the exchange on IRS Form 8824, Like-Kind Exchanges.

There is no penalty if you change your mind about doing a 1031 exchange after engaging a QI or if you do not meet the 45/180 day requirements. The QI will return your money to you and you will be taxed on the sale of your property as if you had sold it outright. However, you will still have the pay the QI their fee.

### Boot in a 1031 Exchange

The term “boot” refers to any non-like-kind property that is exchanged.

The most common forms of boot are cash and mortgages. The general rule is that if you receive more boot than you give up, you will have to pay tax on the net amount of boot you receive.

Cash Boot

In a traditional 1031 exchange (i.e. a swap), it is difficult to find two properties that are of exact equal value. So to compensate, one party gives cash (boot) to the other to make up the difference. However, in a deferred exchange, since you are selling your property first and must reinvest all of the sale proceeds in the replacement property to fully defer the capital gains tax, you will generally not be receiving any cash boot. However, any portion of your sale proceeds that you do not reinvest in the replacement property will be considered cash boot to you and you will have to pay tax on that amount.

Mortgage Boot

Caution: Suggested that you assure an equal Mortgage on the Property Exchanged For; or recognized the need to pay taxes on Mortgage Boot.

Mortgage boot is very common with 1031 exchanges. If the property you are selling has a mortgage on it, the relief of the mortgage will be considered boot to you. So to make sure you do not pay taxes on that boot, you must either have a bigger mortgage on your replacement property than you did on your relinquished property or you must invest your own money in the new property to make up the difference in the purchase price.

The formula for determining boot received is as follows: