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Internal Revenue Service Code Section 1031 provides that real estate or property held for investment or used in a business can be exchanged for “like-kind” property that will also be held for investment or used in a business.

 

Through this type of exchange an investor may defer federal, and in most cases state capital gain tax liabilities that would ordinarily be paid.

 

An investor’s capital gain and depreciation recapture income tax liabilities may be deferred indefinitely as long as the investor continues to exchange into like-kind replacement property through a series of Section 1031 like-kind exchanges. In addition at the time of a property owner’s death his or her heirs can inherit the property at a stepped-up basis and therefore the deferred federal and state taxes could potentially to be eliminated.

 

The deferral of income taxes allows a Section 1031 exchanger to reinvest 100% of the cash proceeds and debt into the replacement property. This may provide an investor with the ability to increase the overall value of his or her business property portfolio by trading up in value, improving cash flow or improving capital appreciation opportunities.

 

 

Qualifying Property for Section 1031 Exchange Treatment:

 

  • Commercial - rental
  • Residential - rental
  • Office buildings
  • Industrial property
  • Farmland
  • Raw land

 

 

Vacation homes may qualify as investment property if personal use is minimal and the home is also rented. A taxpayer who uses a vacation home more than incidentally during the taxable year of the exchange is more than likely not holding it for investment purposes pursuant to Section 1031.

 

Split use property that is partially occupied by the investor as a primary residence and partially treated as rental, investment or business use property can qualify for split use treatment under IRS code. The portion of the property that is occupied by the investor may qualify for capital gain treatment as a primary residence, while the portion held for rental investment or business property can qualify under Section 1031.

 

 

Non-Qualifying Property for Section 1031 Exchange:

 

  • Primary residence
  • Securities or other evidences of indebtedness or interest
  • Stocks, bonds, mutual funds, or notes
  • Interests in partnerships, LLC interests
  • Property held in trade or other property held primarily for sale, including property held by a developer or other dealers in property
  • IRS Exchange Requirements

For full tax deferral an exchanger must:

  • Acquire property that is equal to or greater in value than the relinquished property (based on net sale price plus outstanding debt, not equity).

 

  • Replace outstanding debt or mortgage value on the relinquished property with new debt on the replacement property, although the investor may elect to replace the debt with an additional cash contribution. As a general rule an exchanger may always add more cash to a transaction, but cannot pull cash out of a transaction without the potential for a taxable event.

 

  • In some instances an exchanger may wish not to reinvest all the exchange proceeds and instead take receipt of some of the exchange cash, or receive some mortgage/debt relief. In this case the exchanger will be taxed on the amount of cash received or mortgage/debt relief while the proceeds retained in the exchange will be taxed deferred.
  • Reinvest all the net proceeds from the sale of the relinquished property into the replacement property.

 

  • In order to qualify for a tax deferred like kind exchange, the exchanger must ensure the transaction is properly structured, reported and documented. Furthermore the exchanger must intend to hold the like kind replacement property for rental, investment or use in business.

 

  • The IRS requires that the exchanger of the relinquished property never actually receive proceeds from that transaction. Therefore a third party known as a Qualified Intermediary is used to create a reciprocal trade and facilitate the exchange process. The Qualified Intermediary is also responsible for safeguarding and managing the exchange proceeds until replacement property is acquired.

Time Requirements for a Like-Kind Exchange

 

In addition to the procedural steps above, a Section 1031 Exchange is subject to a critical time line and valuation requirements. Within 45 calendar days (including weekends and holidays) of closing the sale of the relinquished property, an exchanger must identify in writing potential replacement properties. Within the earlier of 180 calendar days (including weekends and holidays) of closing the sale of the relinquished property, or by the due date (including extensions) of the exchanger’s federal income tax return, an exchanger must complete the Section 1031 exchange.

Please note:

This material does not constitute an offer to buy or sell any security. Such offers can only be made through a private placement memorandum or prospectus. There are significant risks associated with 1031 Tenant in Common investments and are not suitable for all investors. Our firm does not provide legal or tax advice. Please consult with your tax or legal professional if considering a 1031 investment.

 

 

1031 Exchange Risk Factors:

  • Purchasers will be required to rely on a third party manager to operate the property purchased, and will have little control over the compensation paid to the third party manager.
  • The sponsors and manager of the real estate purchased will often have conflicts of interest that can adversely affect an investor.
  • TIC interests are generally difficult, if not impossible to sell, and are therefore illiquid.
  • Cash flow generated from TIC investments is not guaranteed.
  • TIC interests are illiquid.
  • Use of leverage funds in TIC programs may significantly increase the loss.
  • Tenants can default, which can cut off cash flow to investors.
  • The prices for properties being sold in 1031/TIC programs often are not the result of arms length negotiations.

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If for any reason you can not reach our St. Louis office location by telephone, please contact Arete Wealth Management, LLC at 312-940-3684 for trading, cashiering and other general assistance.

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Check the background of Our Firm and Investment Professionals on FINRA’s BrokerCheck.

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investments + Services

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Alvery Bartlett Group

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