1031 Exchanges. An Overview.

Profiting on the sale of your investment property is an exciting prospect… until you realize you may need to pay a hefty sum in capital gains tax.

A 1031 tax-deferred exchange is a great way to defer tax payments and let your money continue to work for you. Here is a quick overview prepared by our Pioneer Team. If you have any questions, or want to learn more about ways to use a 1031 exchange to grow your wealth, give us a call at 617-575-7188.

(The material contained herein is for informational purposes only and does not constitute tax or investment advice.)

What is a 1031 exchange?

A 1031 exchange allows an investor to sell a property, reinvest the proceeds in a new property, and to defer all capital gain taxes on the sale. The IRS code puts it in these terms:

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like kind, which is to be held either for productive use in a trade or business or for investment."

In plain English: a seller may defer (pay at a later date) all capital gains taxes on the sale of a property, as long as the profit from the property is invested in a similar (like-kind) property within six months.

There is no limit to the number of times you can make such exchanges, so theoretically you can defer your taxes… well… forever, if you continue re-investing in more properties. Nevertheless, there are several important conditions that you need to consider:

Like-Kind

One point of confusion is often over the definition of ‘like-kind.’ I defined like-kind as ‘similar’ above, but there are particular similarities that must be observed. First, the new property must be of equal or greater value as the property you are selling. If you are selling an investment property, and intend to buy the new property as an investment, this would qualify as ‘like-kind.’ As long as the first and second properties in the exchange are to be used as investments, the like-kind requirement is met, even if these properties vary in category (multi-family, hotel, vacation rental, office building, retail chain, shopping center etc.)

Timeline

The seller (also known as investor or exchanger) must adhere to the 180 day timeline set forth by the IRS to make the 1031 exchange. Once the property is sold, the seller has 45 days to identify a new property of equal or greater value. The seller then has 135 days to acquire the new property.

Investments Only

The sold property and acquired property must both be for investment or business purposes only. A primary residence cannot be used on either end of a 1031 exchange.

Debt and Equity

Example: If an exchanger sells a property for $500,000, where there was $250,000 in equity and $250,000 in debt (a mortgage), the seller would need to use all of the equity and pay off all the debt in order to defer all of the capital gains tax. The seller is permitted to add more money to the purchase of the new property and take on additional debt if desired. If the seller does not wish to spend all of the proceeds from the sale, they may do a partial exchange and pay taxes on the difference. This is commonly defined as a “boot.”

Qualified Intermediary

According to IRS regulation, a seller may not receive cash in a sale associated with a 1031 exchange. Any monies received in this case would be taxable. The IRS has ‘safe harbor’ provisions that require the use of a qualified intermediary to oversee the 1031 exchange transaction. The qualified intermediary must be a third-party. They will hold the proceeds from the sale on your behalf and facilitate the purchase of the acquired property. It is important to use a reputable intermediary. If you decide to sell your property to Pioneer, we will gladly recommend several qualified intermediaries in the area who can help facilitate your exchange. (Many local and regional banks offer this service)

Summing Up:

In short, let’s assume you are selling investment property "A" and intend to purchase investment property "B" to qualify for a 1031 exchange:

1. Property B must be identified within 45 days of the sale of property A.

2. Property B must be acquired within 180 days of the sale of property A.

3. The value of property B must be of equal or greater value than property A.

4. The equity of property B must be of equal or greater value than property A.

5. All of the profits from property A must be used to acquire property B, or tax must be paid on the difference.

6. The purchase of Property B must be facilitated by a qualified intermediary.

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Many sellers approaching retirement age wish to sell their investment properties to purchase more stable, passive, income-producing real estate. Some examples include hotel properties, vacation rentals, mixed-use housing/retail developments, medical office buildings, and grocery store-anchored properties. Other historically stable investments have been in single-tenant, net leased properties with credit-rated tenants such as CVS, Walgreens, Burger King, Starbucks, and Verizon. Pioneer partners with several 1031 and DST certified intermediaries and brokers who can help facilitate tax-deferred investments, and advise you on how best to invest to meet your tax, investment, and estate planning goals.

There are a wide variety of interesting and profitable investment options available when you sell your property that most people simply don’t know about. Pioneer offers our 1031 services absolutely free of charge to all of our sellers. Our dedicated staff and licensed 1031 partners will walk you through each step of the process and strive to make sure your new investment is even better than your last!

Have questions? Want to learn more? Call us at 617-575-7188.