As rents climb for both commercial and residential properties, the market value of these properties has also increased. You might be thinking it’s time to sell that apartment building or other investment property you’ve owned for years.
The catch? Your accountant informs you that selling now would cost you tens and possibly even hundreds of thousands of dollars in taxes due to capital gains and depreciation recapture.
What now? This is where a 1031 exchange comes to the rescue.
Under Internal Revenue Code Section 1031, you can make a like-kind exchange of your real property and not recognize the gain immediately. This means you don’t have to pay those taxes now. Your tax liability simply moves to the next property and is deferred for the time being. This frees you up to sell your apartment building or other investment property and exchange it for a property that’s newer, better or easier to manage without the tax burden that would have resulted from a straight sale.
Under the Tax Cuts and Jobs Act, Section 1031 applies only to exchanges of real property and not to exchanges of personal or intangible property. A transition rule in the new law provides that Section 1031 applies to a qualifying exchange of personal or intangible property if the taxpayer disposed of the exchanged property on or before Dec. 31, 2017, or received replacement property on or before that date.
However, certain exchanges of mutual ditch, reservoir or irrigation stock are still eligible for non-recognition of gain or loss as like-kind exchanges.
Properties are of like-kind if they’re of the same nature or character, even if they differ in grade or quality.
While this all might sound relatively simple, it can be a complicated process since there are several types of 1031 exchanges. These include a simultaneous exchange, reverse exchange or even the more common delayed exchange.
There are also time constraints involved. From the closing date on your original property, you have 45 calendar days to identify like-kind replacement properties — up to three if the combined value doesn’t exceed 200 percent of the sale price of your original property. You then have up to 135 calendar days to close on the replacement property or properties. That adds up to a total of 180 calendar days from the sale date of your original property. In addition, you must use a qualified intermediary throughout the process.
A 1031 exchange is well worth the endeavor, but requires a team of trained professionals to guide you. This includes a well-trained commercial real estate broker, reputable exchange facilitator and knowledgeable tax advisor or attorney.