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1031 Exchange

What is a 1031 Exchange?

For investors, a 1031 Exchange may provide an effective tax strategy for tax deferral as part of succession and estate planning. Internal Revenue Code Section 1031 provides that “no gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment”.

Examples of Like-Kind Properties:

  • Office buildings
  • Office buildings
  • Retail centers
  • Warehouses
  • Vacant land
  • Duplexes and triplexes
  • Single family rentals
  • Apartment buildings
  • Condominiums
  • Industrial property
  • Rental resort property
  • Hotels and motels
  • Mineral rights
  • Water rights
  • Air rights
  • Development rights
  • Easements
  • Tenancy-in-common (TIC) interests
  • Delaware Statutory Trust (DST) interests
  • Leasehold interests
  • New York cooperatives

Potential Benefits of a 1031 Exchange

  • Tax Deferral: A properly executed 1031 Exchange may allow investors to defer State and Federal income taxation upon the sale of appreciated real estate, thereby preserving equity and potentially maximizing total return.
  • Ongoing Tax Benefits: A portion of monthly income may be offset by depreciation.
  • Increased Cash Flow: Investors seeking more current income can benefit from non-income producing or under-performing assets into one or more high-quality properties that may generate monthly income.
  • Capital Appreciation: Growth in the overall value of real estate holdings is necessary to overcome the effects of inflation. A 1031 Exchange may provide investors the opportunity to allocate their capital into assets that may increase the potential for appreciation.
  • Diversification: A 1031 Exchange can be a powerful tool to realize investment diversification, which may be achieved by: diversification in geographic region (multiple properties in multiple states); asset class (office, industrial, retail, multifamily); tenant industry and creditworthiness; capitalization structure (debt vs. equity); and/or ownership structure (fee simple vs. leasehold and severalty vs. co-ownership).
  • Passive Investment: One of the positive attributes of a 1031 Exchange for many investors is the ability to relinquish their ongoing property management responsibilities while still maintaining the potential for stable, monthly income from investment real estate.
  • Institutional Quality: Fractionalized real estate investments, structured as a Delaware Statutory Trust (DST), may offer investors the opportunity to own a partial interest in a higher quality asset than they could obtain individually. For example, investors may execute a 1031 Exchange from raw land or residential rentals into large, Class A properties with credit tenants, professional management, and better long-term appreciation potential.
  • Pre-Arranged Financing: With ongoing challenges in the global credit markets, individuals often find it difficult to obtain favorable financing on their own. 1031 Exchange providers can remove this stress by pre-arranging favorable loan terms. Investors then receive their allocated portion of any such financing.

Basic Requirements:

For complete tax deferral, investors must:

  • Reinvest 100% of net sales proceeds into the replacement property.
  • Acquire an equal or greater amount of debt on the replacement property.
  • Identify potential replacement property within 45 days from the date of sale.
  • Close on the replacement property within 180 days from the date of sale.
  • Use a Qualified Intermediary (QI)

Identification Rules:

  • Three Property Rule: The taxpayer may identify up to three properties of any fair market value and purchase any (or all) of them, regardless of total value. This is the most commonly used identification rule.
  • 200% Rule: The taxpayer may identify an unlimited number of properties provided the total fair market value of all properties identified does not exceed 200% of the fair market value of the relinquished property and may purchase as any (or all) of the identified properties.
  • 95% Rule: If the taxpayer identifies properties in excess of both of the above rules, then the taxpayer must acquire 95% of the value of all properties identified.

Process of a Typical 1031 Exchange:

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