What is a 1031 Exchange and How Can It Benefit Commercial Real Estate Investors

What is a 1031 exchange? It means swapping out one investment property for another in such a way that lets you defer capital gains commercial property 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, the 1031 exchange 200% rule can involve multiple properties that can be worth up to double the value of the relinquished property!

What 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
• Starker

Primary Points to Know

There are several things you should know above all else about 1031 exchanges:

1. These exchanges involve swapping properties held for investment or business purposes.
2. Exchanged properties must be seen as like-kind by the IRS in order to defer capital gains taxes.
3. Former primary residences can be used in these exchanges in only very limited circumstances.
4. However, there is no cap on how often you do 1031 exchanges or how many you take part in.

What Counts?

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.

What is a 1031 exchange, and how can they 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

Qualified Intermediaries

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. Intermediaries 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:

1. Commercial real estate can be more lucrative.
2. Cash flow goes up because no property management company is necessary. Residential tenants are being exchanged for commercial clients.
3. 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.

Leverage

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. Leverage in real estate, boosts your buying power if you want a property that is more expensive.

Diversification

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.

Consolidation

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.

Deadlines Matter

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:

1. The first 180 days after you sell the original property
2. The due date of the original sale’s tax return

Given how tightly these transactions must 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.

1031 exchange FAQs

What is the 1031 exchange process, and how can I navigate it successfully?

To successfully navigate the 1031-exchange process, identify a replacement property within 45 days and complete the purchase within 180 days, thereby deferring capital gains taxes by reinvesting the sale proceeds into a new property.

Which forms are necessary for a 1031 exchange, and where can I find them?

For a 1031 exchange, necessary documents include the IRS Form 8824 and other related paperwork to report the exchange to the IRS. You can obtain these 1031 exchange forms from the IRS website or through specialized 1031 exchange service providers.

How does the sale process work in a 1031 exchange?

In a 1031 exchange, when you sell a property, the proceeds are used to purchase another like-kind property, deferring capital gains taxes. This process requires the sold property’s proceeds to be held by a qualified intermediary until they are reinvested in a new property. Understanding what happens when you sell a 1031 exchange property is crucial for maintaining tax deferral and complying with IRS rules.

Can an LLC participate in a 1031 exchange, and what are the requirements?

Yes, an LLC can participate in a 1031 exchange, provided it meets IRS requirements, such as holding the title to the property in the same manner before and after the exchange. The key is to ensure the LLC’s exchange aligns with IRS guidelines to maintain the tax-deferred status. Understanding the 1031 Exchange for LLC rules is essential for a successful transaction.

What is the timeline for a 1031 exchange, and what deadlines should I be aware of?

The 1031 exchange timeline includes two critical deadlines: you must identify potential replacement properties within 45 days and complete the purchase of the new property within 180 days from the sale of the original asset. Adhering to this 1031 exchange timeline is essential for the exchange to qualify for tax deferment.

What are the identification rules for properties in a 1031 exchange?

The identification rules require you to designate potential replacement properties within 45 days post-sale of the original property. You must adhere to these 1031 exchange identification rules, which include specifying up to three properties as potential replacements or meeting certain valuation requirements if more properties are identified, to ensure the exchange’s validity for tax deferment.

How does a Tenants in Common (TIC) arrangement work in a 1031 exchange?

In a Tenants in Common (TIC) arrangement within a 1031 exchange, multiple investors can pool resources to purchase a property, with each holding an undivided fractional interest. Each investor can sell their interest and use a 1031 exchange to reinvest in new properties, adhering to TIC in 1031 exchanges rules, which allow for the deferment of capital gains taxes while enabling investment in larger, potentially more lucrative properties.

What are the rules for withdrawing funds from a 1031 exchange?

The rules for withdrawing funds from a 1031 exchange are strict; taking cash out or receiving other benefits from the sale of the property before completing the exchange can result in the transaction being taxable. To maintain the tax-deferred status, all equity from the sold property must be reinvested in the new property. If you’re wondering, “Can I take cash out of my 1031 exchange?” know that doing so may trigger tax liabilities and compromise the exchange’s tax-deferred benefits.

How do 1031 exchange reinvestment rules impact my next property purchase?

The 1031 exchange reinvestment rules require you to reinvest all of the proceeds from the sale of the relinquished property into the replacement property to defer all capital gains taxes. If you’re pondering, “How much do you have to reinvest in the 1031 exchange?” the answer is the full amount of the sale proceeds to fully benefit from the tax deferral, ensuring the replacement property’s value is equal to or greater than that of the relinquished one.

1031 Exchange vs. Opportunity Zone: Which is the better option for me?

Deciding between a 1031 exchange and investing in an Opportunity Zone depends on your investment goals and tax planning needs. A 1031 exchange allows you to defer capital gains taxes on real estate by reinvesting in another property, while an Opportunity Zone investment offers potential for deferring, reducing, or even eliminating capital gains taxes on a variety of investments. To determine which is better for your situation, consider the “1031 exchange vs opportunity zone” benefits, including the type of asset, investment horizon, and tax implications.

How often can I utilize a 1031 exchange for my properties?

There is no limit on how frequently you can conduct a 1031 exchange; you can engage in multiple exchanges over time. If you’re wondering “how often can you do a 1031 exchange,” know that as long as you adhere to the rules, such as using the property for investment or business purposes and following the timeline and identification requirements, you can continuously defer capital gains taxes through successive 1031 exchanges.

What is a qualified intermediary, and why do I need one for a 1031 exchange?

A qualified intermediary is an essential component in a 1031 exchange, acting as a neutral third party to facilitate the transaction by holding the sale proceeds and ensuring all IRS guidelines are followed. The necessity of a 1031 qualified intermediary arises from the requirement that the investor does not take actual or constructive receipt of the sale proceeds before acquiring the replacement property, ensuring the exchange’s validity and compliance with tax-deferral rules.