A 1031 exchange is a tool for investors in commercial real estate to defer capital gains taxes on the sale of a property. It’s based on Section 1031 of the U.S. Internal Revenue Code. In order to qualify, the proceeds are reinvested in a like-kind property.
This is a particularly valuable tool for investors looking to expand or diversify their commercial real estate portfolios while preserving their capital and leveraging tax deferral to enhance potential returns. There are very specific requirements that must be fully met in order for investors to reap the benefits of a 1031 exchange.
Understanding like-kind exchanges
A 1031 exchange must involve like-kind properties in the United States. Like-kind refers to the use of the property instead of the quality of it. This means that a real estate investor can sell an office building and then reinvest the proceeds into another commercial property, including an industrial property or a retail business. The key here is that both properties must be considered investments.
The process and timelines
A 1031 exchange is subject to strict timelines and guidelines. There’s a 45-day deadline from the sale of the initial property to the identification of potential replacement properties. There’s a 180-day deadline from the sale of the initial property to the closing on the replacement property. If these timelines aren’t met, the investor will forfeit all benefits of the 1031.
Qualified intermediaries
A qualified intermediary (QI) must handle the proceeds of the property that’s sold. At no point during the sale or purchase can the investor handle the proceeds. If the investor ever receives the funds, the benefits of the 1031 exchange are voided.
Because there’s a lot at stake with a 1031 exchange, investors should ensure they have a legal representative to oversee any applicable transactions. This can help to protect their interests and better ensure compliance with all applicable laws.
