The 561 Exchange is an industry term used to describe a real estate transfer based upon IRS Publication 561. Through the 561 Exchange, title is conveyed to the recipient and with the right type of property, the tax benefit generated for the owner can often match the after-tax cash benefit derived if the property was sold at list price.
In order for the 561 Exchange to work, three criteria must be met – the right buyer, the right seller and the right property. The program then uses the combination of the three appraisal methods as outlined by the IRS in Publication 561 of the tax code to determine the Fair Market Value of the property – the replacement cost approach, the income approach and the market approach. Once the value is established, the seller conveys the title to SeedAmerica and receives the cash from the tax benefit, usually exceeding the cash benefit of selling it at list price.
One of the biggest problems that corporations and individual investors owning large industrial and warehouse properties face is how to deal with the changing economy, as more and more companies move their manufacturing overseas. With China and other Asian countries becoming more competitive in industrial related products, American corporations and individual real estate investors have a growing number of empty properties with few good financial solutions at their disposal. The U.S., specifically in the Midwest, has a large number of industrial properties that are now empty and no long producing. This not only effects the owner of the property, but the local communities and the American economy.
A typical property may be anywhere between 50,000 sq. ft. and 500,000 sq. ft. The cost to maintain these properties and keep them empty is staggering. Not only do you have high property taxes, insurance, but most properties must continue to pay a high rate for electric and heat, even if it’s empty, due to fire and safety regulations with the sprinkler systems. Some corporations have paid $30,000 per year in water even though it did not consume a drop during that period. On top of that, corporations have a designated maintenance person to oversee an empty building while it sits on the market—and sitting on the market is what these properties do best.
The sales cycle of a typical property may be anywhere between 3 to 5 years. The only reason some of properties move after 5 years is because the owners gets frustrated with paying carrying costs, month after month, so they will do anything to dispose of the property, no matter what the return. A 100,000 sq. ft. property can pay over $1 million dollars in these carrying costs while it sits on the market. Instead of a company focusing on what they do best and growing the business, time and energy is drained with the headache of maintaining the empty property. In the end, when the property does sell, the owner usually receives a fraction of that cost back.
So, as the demand for industrial properties keeps decreasing and the supply keeps increasing, this problem only gets more and more costly. However, even in this uncertain and difficult economic climate, some companies have found a great solution, not only to their headache of costly empty properties, but also solutions that the local community and the company’s shareholders love - the 561 Exchange.
Corporations often acquire new companies for their brands and later move or consolidate the production sites of the new companies to create more efficient operational plans and lower production costs. As word of a manufacturing plant's impending closing circulates, the local community is usually not very happy, as the lives of many people would change from the layoffs. The plant starts to receive negative publicity as their costly building in this small Texas town sat empty, along with other costly empty industrial buildings in nearby communities.
One year later, that very same building was full of enterprising businesses, became the site of the county's Business Expo and positive publicity followed. But what’s more impressive about this transformation is that the company received a bigger cash benefit for the property than they ever expected. How? They learned the solution that more and more industrial property owners are discovering—the 561 Exchange.
Many Fortune companies,as well as several thousand smaller ones have received tax benefits for empty industrial properties, better than if they would have sold it outright at list price while using the 561 Exchange. On top of that, the average sales cycle for a 561 Exchange is 45 days instead of 4 years, which cuts down the carry cost dramatically.
The catch is that the 561 Exchange only carries a tax benefit to the owner of the property if the company is profitable or expects to be profitable within the next 5 years. If the owner of the property is an individual investor, the owner must pay a certain amount of income taxes in order to exceed the cash benefit of selling it at list price.
The second criteria is that it has to be the right property. The 561 Exchange typically only works on industrial properties of a certain size. It does not apply to homes, apartments, condos, etc. If the property is downtown a thriving metro area like Tampa, Florida—it probably will not apply. However, if the property is 50,000 sq. ft. or higher in a small rural area or economically sluggish city, then it will probably work.
The third criteria is that it has to be the right buyer or recipient. Typically, a national 501(c)3 organizationsuch as Safe Harbor Foundation that focuses on 561 Exchange properties. This 501(c)3 organization works with corporations that have empty buildings usually because of a plant closure and helps the local communities gain those jobs back by utilizing the empty property to start new entrepreneurial businesses or help existing ones create more jobs.
Instead of attacking corporations for being more competitive by moving certain aspects of the business to other locations or even overseas, Safe Harbor Foundation encourages plants to do whatever it takes to increase their profitability because this entrepreneurial mindset is the only thing that will have long-term sustainability instead of the short-sided protectionist mentality.
Safe Harbor Foundation helps communities and companies dealing with brutal economic conditions. We work with the companies closing down plants, the unemployed, and the government—federal, state, and local to come up with the best solution for the problem.
It’s a win-win solution. The property owners win by disposing the property and getting a significant cash benefit without the huge carrying costs incurred while it sits empty on the market. The local community wins by helping entrepreneurs create more small business and jobs. The government wins by the creation of more profitable tax paying businesses that use what could easily have been an empty building.
Similarly, a small cabinet making business was struggling to stay open. After the landlord evicted them, they had no place to build their cabinets and was going to be forced to shut down. Through the efforts of the local community,Safe Harbor Foundation was able to give them free space in what is known now as Vonda Village to build their cabinets and keep their business open. Similar stories of small business owners being forced out of high priced leasing situations have met with a very happy business owners.
Believe it or not, the 561 Exchange is simple. All it requires is a certified appraisal following the rules and regulations of IRS Publication 561. It must take into account the replacement cost approach, income approach, and the market approach in the appraisal. Given the right size industrial property, these appraisals can far exceed the value attained in selling the property
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Industrial property owners have now found a solution to their costly empty property problem. In fact, some property owners like the 561 Exchange so much that they have used it for properties that were occupied and producing income.
Before jumping on the 561 Exchange bandwagon, CPAs recommend working with a national 501(c)3 such as Safe Harbor Foundation that can deliver the greatest benefit in terms of giving back to the community, positive public relations, and of course the best financial benefit.
Some 501(c)3 organizations who have experience using the 561 Exchange often give the property owner a substantially lower financial benefit, as was originally the case with Tempest, as they were preparing complete a similar deal with another 501(c)3 organization that would have given them less than half of the cash value thatSafe Harbor Foundation was able to deliver.