Prudent investors are now taking advantage of one of the last remaining IRS Codes to defer taxes………the 1031 Exchange. The IRS Section 1031 exchange (like-kind) is not a new tax tool, in fact the 1031 exchange has been around since the 1920’s. The U.S. Income Tax Code allows individual investors, as well as corporate owners of real estate to sell their property and defer their capital gains by exchanging the proceeds from the sale of their asset into an investment in another “like-kind” property. The 1031 works for retail, commercial, office, industrial, multi-family and land.
In order to affect the 1031 exchange, the seller must place funds from the initial transaction into a special trust account designated specifically for this purpose. The types of accounts are usually preserved by banks, trusts or other financial institutions. It is very important to pick a very reputable intermediary. Typically an intermediary helps effectuate the entire 1031 process.
When an entity decides to sell a property, they have 180 calendar days from the closing their initial property to complete the 1031 exchange. The first 45 days is considered the designation period whereas the seller must identify and designate properties that they wish to exchange into. The seller may designate up to three properties or may designate a group of properties with a combined value that does not exceed 200% of the value of the initial property. If no properties have been identified by the end of the forty-five days or no property designated at the end of the 180 day period is completed, the trust is liquidated and the trust will be taxed at the current capital gains rate.
A new type of exchange was introduced a few years ago called a Reverse Exchange. This allows an investor to acquire a “like kind” replacement property prior to disposing of an existing property. The same time periods apply here as in a traditional 1031.
In order to affect the 1031 exchange, the seller must place funds from the initial transaction into a special trust account designated specifically for this purpose. The types of accounts are usually preserved by banks, trusts or other financial institutions. Typically an intermediary helps effectuate the entire 1031 process. Regardless, the application of a 1031 exchange to any transaction can only be determined after careful study of a taxpayer’s particular facts and circumstances. It is always a smart idea to consult with your tax advisor, accountant, attorney, real estate agent and/or intermediary.
1031 Exchanges and Net-Leased Properties
Initially, when the IRS decided to reduce capital gains to fifteen percent, many investors chose to take the tax hit rather than defer the gain utilizing a 1031 exchange because their reinvestment rate was tremendous due to the go go days of the stock market. However, these days deferring the gain makes more sense when one can trade into a single-tenant net leased property at a stable rate of return.
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