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General Information / Investor Services

The Great Exchange (1031 Exchanges)

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Paul in his officeAuthor: Paul Branton

The Great Exchange… no, I’m not talking about Obama v. Trump. While it would be apropos to discuss politics and the “transfer of power” or “alternative facts” in light of that recent great exchange, I would rather stick to what I know best and that is REAL ESTATE.  (Real Estate also happens to be a lot more fun!)

The Great Exchange that you should know about as a seasoned or potential real estate investor is known as the 1031 Exchange.

In the past few weeks, I’ve had the pleasure of working with two of our investment property owners that are in the midst of navigating through the requirements and timelines associated with what is commonly referred to in real estate and the tax code as a 1031 Exchange. (also known as a Starker Exchange.)

With this fresh in mind, I wanted to take the time to share the basics of what you should know about these types of property exchanges.

2 quick notes:

  1. Be sure to consult a tax professional before considering a 1031 Exchange.
  2. In June of 2016, the House Republicans created a “Blueprint for Tax Reform” called A Better Way. The proposed changes threaten 1031 Exchanges. If you’re considering an exchange, you may want to pursue it before any substantial changes are passed.

What is a 1031 Exchange?

  • A 1031 Exchange is a wealth building strategy known as Internal Revenue Code Section 1.1031. It’s used for the exchange of real and personal property held in the productive use of a business or for investment.
  • With each 1031 Exchange is a timeline requiring strict adherence.

What are the Timeline Requirements?

  • Starting from the day the “relinquished property” closes, you have 45 days to “identify” potential replacement property.
  • Starting from the day the “relinquished property” closes, you have 180 days to acquire the replacement property.
    • The exchange must be completed in 180 days. (not 45 + 180)

How do I “Identify” a “like kind” replacement property?

  • By the end of the identification period, the potential replacement properties must be unambiguously identified to the qualified intermediary. (Legal Description or Property Address)
  • You may identify up to three properties of any value with the intent of purchasing at least one.

What is “Like-Kind” property?

  • This is a very broad term, meaning that both of the properties must be “the same nature or character, even if they differ in grade or quality.”
  • In terms of real estate, you can exchange nearly any type of property, so long as it’s not personal property.

What is a “Qualified Intermediary”?

  • This is the name for the entity through which the proceeds from the sale must pass.
    • The proceeds from the sale must go to a qualified intermediary in order to be reinvested and remain tax deferred.
    • The sale proceeds must not come to you or they become taxable.
  • Any proceeds retained from the exchange (“Boot”) will become taxable.

Why should I do a 1031 exchange?

  • The main reason is the tax deferral of the federal and state capital gains and recaptured depreciation taxes assuming the replacement property is of equal or greater value and is acquired within the exchange timeline.
  • The 1031 exchange allows you to, rather than paying the tax, use those dollars towards a replacement property that may generate additional cash flow, have greater depreciation, be in a better location or no longer require as much effort to maintain.

In summary, a 1031 exchange has limitations and guidelines, but when done correctly could help you offset or defer paying capital gains taxes on your investment properties.

Until next time….
Paul