Editor’s Note: Almost always, a Seller should consider all
consequences of Selling their property. The well known
“1031 Exchange” is such important part of American tax
law that every owner should know.
How a 1031 Exchange Can Help You Reclaim Your Life
Posted: Apr 08, 2011
 
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Too often a successful real estate investment comes at the expense of something
else which is very valuable: time. As buildings age the amount of time needed
to address the rising needs of tenants, as well as increasing maintenance costs,
chips away at what might otherwise have long been a great investment. As a
remedy to these problems real estate owners are looking to IRC §1031 tax
deferred exchanges for a solution.
Real estate owners have had the option of deferring the recognition of a
capital gains tax by exchanging real estate, rather than engaging in a sale and
subsequent purchase, since 1921. And although much has changed since then, the
basic concept remains: A properly structured tax deferred exchange under
section 1031 of the Internal Revenue Code allows an owner of real estate to
defer the recognition of a capital gains tax normally recognized on the sale of
real estate, if the real estate owner buys a like kind property of equal or
greater value and uses all of its cash equity in the subsequent purchase.
Simply put, taxpayers are selling their management and cost intensive
properties, buying low or no management properties, and utilizing an exchange
so as to not realize any capital gains tax. Many real estate owners mistakenly
believe that the “like kind” requirement means that if they are selling an
apartment building they must also buy an apartment building. Nothing could be
further from the truth.
Like kind refers to any property held for business or investment purposes.
What that means is that a real estate investor may sell an apartment building
and buy, for example, a strip mall, office building, or a net leased restaurant.
As long as the property being sold and the property being purchased are real
estate, they can be exchanged, no matter what the property use is. Of course
there are some limitations for this general rule. For example, you may not
sell your primary residence and structure it as an exchange.
An exchange is also an important part of retirement and estate planning. For
example, an owner of an apartment building may choose to structure the sale of
that building as an exchange and purchase a single family home on a golf course,
and a net leased pharmacy. To satisfy the requirement that all properties sold
and purchased in an exchange are business or investment properties the single
family home is leased to a tenant through a management agent for a period of
several years. Thereafter, the intent of the real estate owner changes from an
investment use to a personal use, and the property is used as a primary
residence or vacation home. The net effect is that the investor has sold a
high maintenance and cost building and exchanged it for a management free net
leased investment, as well as a potential retirement or vacation home, all
without incurring any capital gains tax.
Although the rules to obtain a full deferral of a gain require that you use 100%
of your equity to purchase the replacement property, there are several options
for obtaining the use of those funds. First and foremost, there is always the
option of only structuring an exchange with a portion of the funds received
from a sale, in which case an investor is taxed on the amount that was not
reinvested. A much better approach is to use 100% of the funds received from
the sale property to purchase a replacement property structured as an exchange,
and thereafter refinance the replacement property to gain the use of those
funds. The income from the replacement property will take care of the debt
service on the financing, and the investor is able to use these refinance funds
tax free.
There are a myriad of ways in which an IRC §1301 exchange can help a real
estate investor. In order to obtain the maximum benefit it is always useful to
obtain information from a trusted qualified intermediary and review it with
your tax and/or legal counsel.
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Article by Legal 1031 Exchange Services, Inc.
To get started, contact us early, even if you may not be ready to sell or exchange yet.
