What is a 1031 Exchange?
A 1031 exchange is one of the best tax strategies for real estate investing. The 1031 exchange rule allows a real estate investor to sell his commercial property and roll the profits into a ‘like-kind’ exchange property without paying capital gains tax on the real estate investment sale.
Here is a simple example to illustrate how a 1031 exchange would effect a real estate investment (note: tax code changes often and there are many other rules and regulations involved). Assuming an individual is in the 39% tax bracket, there would be a 20% capital gains tax on the sale of an investment property:
- Sale of Real Estate Investment: $3,000,000
- Capital Gains Tax @ 20% of sale: $600,000
- Total profits before expenses: $2,400,000
By properly executing a 1031 exchange, the investor would be able to defer the capital gains and not pay the $600,000 capital gains tax.
1031 Exchange Rules and Requirements
Some of the major rules and requirements of a 1031 exchange are:
- The seller must identify a similar ‘like-kind’ exchange property within 45 days of closing on the real estate investment property.
- A 1031 exchange property must be closed on within 180 days of closing on the real estate investment property.
- The price of the 1031 exchange property must be equal to or greater than the relinquished property.
- The same taxpayer who sells the property must buy the property.
The most common question asked is “what is a ‘like-kind’ property”? While the term ‘like-kind’ is very broad, it is important to remember that a 1031 exchange cannot be used for personal use. An individual cannot exchange a primary residence for another home, but one could exchange a rental home for another rental. Other examples of acceptable transactions would be exchanging an apartment building for another apartment building, an apartment building for raw land, or retail investment property for an industrial investment property. The options for a ‘like-kind’ exchange are vast.
How can a commercial broker help with a 1031 exchange?
First and foremost, using an experienced commercial broker can improve the performance of the real estate investment. Our commercial real estate brokers are able to assist with identifying investment properties quickly while maximizing net operating income (NOI). Also, the rules and regulations are constantly changing and the process can be overwhelming. Having an experienced team helps simplify the process and eliminate stress.