Jersey Shore Business Journal

Picking the brain of the 1031 exchange guy

June 18, 2008

The discussion amongst a group of realtor’s ran the gamut. Seated at the table in the great room of the large seashore duplex, the professionals enjoyed a delicious buffet while discussing everything from the weather and the wacky world of summer rentals to interest rates and the glut of unsold single family homes.
Networking and hobnobbing; the seashore home was abuzz. I couldn’t help but notice a crowd developing in the kitchen; a polished, genteel man appeared to be holding court and his audience was captivated.
“Who is he?” someone asked.
I too, was curious; some of the best and brightest in the business were mesmerized. The questions were swirling and he seemed to have all the answers.
The gentleman, George Christofely, was well-known to most.
“He’s brilliant,” someone said. “Want to know what’s going on in the market, pick his brain. He’s the 1031 exchange guy, incredibly knowledgeable. The guy’s amazing.”
The ringing endorsements of his brainpower convinced me; if the movers and shakers were so enamored by his wisdom, I wanted to talk to him.
In a broad-ranging interview, I tapped his minds’ inner workings about everything from the local real estate market to the national economy, and to my fascination, the tax-free exchange, or phenomenal wealth-building investment mechanism from which his brilliance emanates.
Christofely is the vice president and general manager of Jersey Realty Exchange Corporation, a local company otherwise known as a “qualified intermediary” providing the expertise for the tax saving tool known as the tax deferred investment strategy, or “1031” exchange.
A tax deferred exchange is a method by which a property owner trades one property for another without having to pay any federal income taxes on the transaction. Ordinarily, the property owner is taxed on any gain realized. In an exchange, the tax on the transaction is deferred.
“The IRS is saying that taking a large percentage of the profit would cripple a business owner or investor, preventing him from expanding,” said Christofely, who is also a certified public accountant.
Maintaining one’s reputation as a tax-free exchange expert requires one to be a real estate connoisseur; the master of a complex industry. Nearly five inches thick the imposing regulatory book is second nature to the scholarly, but much of the business is interpretation. There’s black and white, but lots of gray, but no room for error.
“You have to know everything in that book, and you have to have the answer at your fingertips,” he said. “I’d say 10 percent of what we do is vanilla, 90 percent is out of the box. There is a difficult, technical component. You have to understand real estate and be a specialist in the tax code, like a surgeon in the medical field. You can’t buy knowledge and experience. Being a CPA makes it much easier for me.”
Christofely says he thinks the sluggish local market has likely leveled off.
“In my opinion we are on the road to some sort of recovery, things have stayed consistently level the past year,” he said. “It may be contrary to the economy in general. The economy is still in a state of flux, you have a lot of people out of work, a blip in the unemployment rate up to 5.5 percent. The stock market is up and down, tumbling on the unemployment news. A lot of people are delinquent on their mortgages.”
Yet our local market is bottoming out; is this the time to jump in?
“If you’re going to get in the market, this is the time,” he said. “Sellers have taken a long time to adjust, and some builders even longer, but I think with the way prices have come down we hit the bottom. We’ve seen builders dropping prices. I don’t think we’ll see another price decline, we are there. We are seeing more activity because we have had a meeting of the minds between the buyers and the sellers.”
Christofely says we were, in effect living a “fantasy” leading up to 2005.
“There was a lot of solid investment, but also a fair amount of greed,” he says. “Some got themselves over-extended; they were blinded by their greed. We were seeing 20 to 25 percent appreciation, that couldn’t continue. People were coming into the market without the necessary financial means. That’s why you see places like Wildwood with excess inventory while Avalon and Long Beach Island have stabilized; they attract buyers with financial strength and can sustain themselves in tough times.
”The average working class person who stretched to buy the $400,000 property with 100 percent financing can’t afford a bad month, let alone a downturn. These properties were considered lottery tickets. That’s why things went so crazy in 2002,” he continued. “The banks went wild, they allowed people to buy these properties with no investment of their own, just bank money. The sad part is that we are now seeing short sales; people are upside down, under water on their mortgages.
“This affects a lot of people,” he said. “You are seeing other businesses struggling, those who support the industry, sell appliances, home goods and so forth.”
Christofely says the presidential election could affect the economy.
“President Bush established a capital gains rate of 15 percent, a new president could change that,” he said. “Barack Obama has suggested 25, 30 percent. If that happens it only helps my business, it makes it more attractive to invest in a tax-free exchange because there is no capital gain. People who invest will be motivated to look for a safe harbor. With the economy, gas prices, and downsizing we are in turmoil, but I think the real estate industry has seen the bottom. People are spending money, Ocean City rentals are the best ever. I don’t think it’s such a bad situation here, things are pretty good.”
Interestingly, any “real” property can be exchanged, from boats and airplanes to mineral rights and conservation easements. It must be “like-kind.”
“It started with farmers, in the 1920s,” he said. “Farmers swapped their deeds, so they each had the best soil for growing things like corn and potatoes. The government had good intentions. It was later called the Starker Exchange in the 1970s after a fellow named Starker battled the IRS. He sold a property and years later tried to claim an exchange.
“That fueled an industry in the late 1980s when Congress passed a law saying you couldn’t deduct losses. The rules were tightened and the 1031 became more popular and beneficial as people became more knowledgeable. The IRS established qualified intermediaries, a policeman for the IRS. It started on the West Coast. It’s a wonderful marketing tool, Realtors should take advantage.”
The tax-free rules are complicated; the 1031 is a “safe harbor,” but you need a seaworthy vessel.
“When the market took off, a lot of people suddenly became 1031 experts,” he said. “You want to deal with a company that does nothing but 1031 and does not dabble in something else. We sell knowledge and experience. It’s a service; but what you do has to pass an IRS review. It’s critical to make sure your transaction is above reproach or it could cost you a lot in taxes. I go to national meetings and half the companies have had audits, we have not had one in 14 years nor have we had an exchange overturned.
“We tell our clients the rules, this is an investment. You have to rent it out; there is a fine line between second home and investment property. You can’t use it more than 14 days a year other than maintenance and you can’t use it as your permanent home for two years before or two years after the exchange,” he said. “You can at some point make it your permanent home. It takes a lot of forethought. The usage right before the sale determines the tax treatment.
“The whole intent is to allow a business owner or investor to trade one property for something more suitable, the exchange is not taxed,” he said. “They can do this, every two years, without losing a chunk of the profit to taxes.”
In an exchange, a property owner disposes of one property and acquires another, but it must be structured in such a way that it is in fact an exchange, rather than sale of one property and purchase of another. You have 45 days to identify a replacement property after closing, and 180 days to make the next settlement.
“The best thing is that you can trade up, and it doesn’t pass along with your estate,” he said. “You don’t leave a tax burden to your heirs. It ends with you.”
Christofely became a tax-deferred expert the old-fashioned way; he earned it. Tired of the accounting business, he sold his Edison firm and moved to Long Beach Island.
“I bought investment properties,” he said. “I started thinking how I could do it without paying so much in taxes. It’s hard to move up if you have to keep paying tax on each transaction. I learned everything I could.”
Word spread of Christofely’s success. Soon he was offering seminars. Local Title Company of Jersey executives heard about him and put him in charge of their new venture, Jersey Realty Exchange Corporation 14 years ago. That was 5,000 aggregated properties and $2.2 billion worth of exchanged properties across the United States.
The economy has not helped Christofely’s business. Low interest rates reduce profits on funds held in exchange. When investment sales are slow, his business is slow too.
“We lost the market from 2004 to 2008,” he said.
While optimistic, Christofely says there are signs of trouble. The road to recovery won’t be easy.
“It’s almost impossible to get an undocumented loan,” he said. “The pendulum swung wildly. We’re back to the 1950s and 1960s. Banks just want to write with good people. Investors walked away from risky loans. The affected flooded the market. The problem was that 10 people were bidding on a property but only three were really qualified to buy it. It drove prices up, inflated homes and eliminated people from the market leading to a decrease in value.
“We went for a roller coaster ride,” he said. “It was like bunging jumping off a bridge, the fun is over,” he said. “It’s now survival of the fittest. Unfortunately some created a bad name for the industry.
“We may not see in our lifetime what we experienced in the past decade,” he said. “We’re going to be back to a normal market, with steady gains. If you look back, and take out the past six years, we’re right about where we would have been.
“Real estate will always be a great investment, for the long-term,” he said.




Ann Richardson can be e-mailed at annrichardson@catamaranmedia.com or you can comment on this story by calling 624-8900, ext. 223.