Here’s another indicator that the economy is improving: People are investing in 1031 Exchanges again.

A 1031 Exchange is an IRS-sanctioned way to defer paying capital gains taxes (typically 15 percent) on investment property. It works like this:

I buy a rental property for $100,000 and invest $10,000 in upgrades. If I sell it for $150,000, I can avoid paying capital gains tax by reinvesting that money in another, more expensive property.

I can continue to do this, buying ever-better properties, indefinitely. When I sell the last property, I will have to pay capital gains tax on that property alone (presumably I make the final transaction when I retire so my overall income is lower, thereby reducing my tax liability.)

Real estate professionals see an uptick in 1031 Exchanges when markets are hot, as they are in Portland right now. Jim Hopkinson, a lawyer trained in handling 1031 Exchanges, says his practice has seen a 15 percent to 20 percent increase in inquiries from clients about the tax deferment program.

“With the economy improving and real estate values starting to come back, I’m seeing 1031 becoming attractive to sellers with taxable gains who are not looking to cash out of the market,” said Hopkinson, who has noted the increasing interest in 1031s since the last quarter of 2014. The other advantage is the tax deferment program is “fairly easily understood by less sophisticated investors” who might be put off by more complicated investment strategies.

Brit Vitalius, owner of Vitalius Real Estate Group, presented on the multifamily market at the annual Maine Real Estate and Development Association forecasting conference in January. He’s observed several 1031 Exchanges affecting property sales in Portland. In one example, an investor bought a multifamily building on Munjoy Hill, upgraded it and then sold it using money from that sale to buy a six-unit building at 287 State St. for $475,000.

Investors who tap the 1031 deferment liken it to getting an interest-free loan for their next investment. Rather than paying a 15 percent capital gains tax to Uncle Sam, they can take that money and roll it into the next investment property.

Steve Morrison, owner of Morrison Real Estate on Danforth Street, has been involved in 60 to 80 1031 Exchanges in his 33 years in real estate. But in 1984, he got some firsthand experience when he and his wife bought a small mixed-use property in Willard Square in South Portland for about $50,000, held on to it for 20 years and then sold it through a 1031 Exchange. They used the money from that sale to buy a multifamily building in the West End, which they still own.

“But basically, in that experience, we made a $50,000 investment that’s now worth $500,000,” he said. “These are investments made for the long haul.”

He said the recent uptick in 1031 Exchanges he’s been observing seem to stem from investors’ greater confidence in the real estate market than the stock market.

“These investors want a good return on their money – it’s about keeping that money working for you,” he said. In the stock market, “there aren’t a lot of good alternatives.”

SINGLETARY’S NEW HOME

A few weeks back we redesigned the Sunday business section, adding a week-in-review of the top Maine business news. To accommodate that change, we had to move some things around, and Michelle Singletary’s column on personal finance was one of them.

If you’re looking for her, you can find her every Monday within our daily business e-newsletter. To sign up – it’s free – just go to www.pressherald.com/business/ and look for “business headlines.” You’ll get Singletary’s personal finance advice, as well as the top business news of the day.

Carol Coultas is business editor at the Portland Press Herald. She can be contacted at 791-6460 or at:

ccoultas@pressherald.com

Copy the Story Link