What is a 1031 exchange? It means swapping out one investment property for another in such a way that lets you defer capital gains taxes.
How can a 1031 exchange benefit commercial real estate investors? If you are swapping like-kind properties, then deferring capital gains taxes can mean it’s cheaper and easier to get out of one property while getting into another.
Residential real estate investors looking to get into commercial or industrial real estate might be able to arrange such a transaction to facilitate their movement into a new kind of real estate. Likewise, commercial real estate investors looking to reduce their portfolio or offload certain properties might be able to simplify their assets. In some cases, 1031 exchanges can involve multiple properties rather than just selling one to gain one.
What Exactly Is a 1031 Exchange?
According to Investopedia, these exchanges get their name from Section 1031 of the IRS code. The term is used by investors, realtors, and title companies, among others.
Some individuals actually use the term as a verb instead of just a noun. Talk to enough investors, and you’ll eventually hear someone say “We should 1031 that property for something else.” It’s also common for someone to type “1301 exchange” into Google rather than “1031 exchange”.
A 1031 exchange can be called other things:
- Like-kind exchange
Primary Points to Know
There are several things you should know above all else about 1031 exchanges:
- These exchanges involve swapping properties held for investment or business purposes.
- Exchanged properties must be seen as like-kind by the IRS in order to defer capital gains taxes.
- Former primary residences can be used in these exchanges in only very limited circumstances.
- However, there is no cap on how often you do 1031 exchanges or how many you take part in.
The IRS phrase of ‘like-kind’ isn’t as obvious as you might assume. It’s not so much about the specific purpose of a piece or property so much as it is the investor’s purpose behind a property. Generally speaking, you can exchange any profit-generating property for another. You can even exchange businesses for one another.
This means that you can exchange a commercial strip mall for a farm, or a medical complex for undeveloped land. Those properties might all serve different sectors, but the property owners all consider them commercial properties of sorts.
What investors don’t do with any of those properties is live on them. There are loopholes for swapping out vacation homes, but the rules for that are much tighter than for genuine commercial properties.
How Can 1031 Exchanges Benefit Commercial Real Estate Investors?
According to CWS Capital, whenever you sell a property, the proceeds you get from such a sale are taxable. In a 1031 exchange, transferring those proceeds to a qualified intermediary instead of you as the seller means you can reinvest those proceeds into the acquisition of a new property.
The financial advantage should be immediately obvious:
- Without a 1031 Exchange: Your sales proceeds – capital gains taxes = your new property purchase budget
- With a 1031 Exchange: Your sales proceeds = your new property purchase budget
Using 1031 exchanges lets you get out of old properties:
- Without losing money during the process
- Without having to sink money into the transaction if the new property is as valuable as the old one
According to CPA Journal, over a quarter million exchanges get filed every year. The cumulative value is over $70 billion.
A whole industry has popped up surrounding qualified intermediaries necessary to facilitate like-kind exchanges. Qualified intermediaries are either businesses or individuals that make these exchanges possible because they hold the funds that are involved in the transaction until such point they can be transferred to sellers of replacement properties.
This is the only role qualified intermediaries can have. They are not allowed to have formal relationships of any other kind with any party that is exchanging property.
Moving Into Commercial Real Estate
Some real estate investors start with residential properties because:
- Things are generally simpler
- The entry costs are lower
However, if they’ve generated enough resources that they want to move into pure commercial property, then a 1031 exchange might make that possible.
Consider an instance where an investor has a pair of duplexes in their portfolio with multiple tenants providing rental income. Assume the investor would rather have an office building with just a single tenant.
Using a 1031 exchange of the two duplexes for a single replacement could yield several benefits, according to Property Cash In:
- Commercial real estate can be more lucrative.
- Cash flow goes up because no property management company is necessary. Residential tenants are being exchanged for commercial clients.
- Maintenance costs are eliminated because the tenant would assume responsibility for such matters. The tenant might even shoulder the burdens of property taxes and insurance.
Investors that hold property that generates no revenue can certainly take advantage of 1031 exchanges. Imagine you own undeveloped land or structures with no tenants. You can free yourself of those for properties that do generate revenue. Without losing any overall value in your total assets, you can start enjoying passive income streams just by rearranging your properties.
According to First Exchange, you can use 1031 exchanges to upgrade your investment options. Since you won’t pay money in capital gains taxes, you can put down larger down payments. This boosts your buying power if you want a property that is more expensive.
Using 1031 exchanges is something you can do between properties anywhere in the United States. If you own properties in repressed or sinking markets, you can swap them out for property in areas of high growth. You can expose yourself to many different local markets from coast to coast. This is also a great way to convert single properties into multiple properties for more income streams.
If you feel like your portfolio is stretched too thin, or you just want to simplify matters, you can swap out multiple properties for a single property. Alternatively, you can swap three or four for just two, reducing how much you have to keep up with.
Don’t Go It Alone
Making decisions about commercial real estate is a big deal. Your best bet is contacting a professional investment company before you commit to anything.
Point Acquisitions is a good choice for you to consider. We are actually considered rather disruptive by conventional commercial real estate companies because of how quickly and efficiently we move. Those are advantages to you, however.
PointAquistions is an e-seller, and we work in the commercial real estate sector a lot like how Opendoor or Redfin operates against traditional real estate agencies, such as Remax does for people buying homes.
To make the most of a 1031 exchange or any matter in commercial and industrial real estate investing, contact the professionals of Point Acquisitions for the best expertise, options, and advice in this sector.
In order for a property you sell to qualify for a 1031 exchange, you only get 45 days to identify one to three replacements. According to MillionAcres, the actual 1031 exchange has to happen by the earliest of two dates:
- The first 180 days after you sell the original property
- The due date of the original sale’s tax return
Given how tightly these transactions have to be conducted, using a service such as Point Acquisitions is crucial to your success. The speed and efficiency with which they can buy commercial properties can help you with your 1031 exchanges.