1031 Exchange Rental
About 1031 Exchange Rental
1921 investors have been given the opportunity to defer the capital gains tax from the sale of a property by using
Deferred 1031 Exchange allows an owner of real property, the Exchanger, to defer the recognition of a capital gains
tax normally recognized on the sale of real property, if the exchanger buys a like kind property of equal or
greater value and uses all of its cash equity in the subsequent purchase.
kind property does not mean an office building to be exchanged for another office building or free standing single
tenant retail property to be exchanged for another single tenant retail property. There is no requirement that
properties be similar in type or class. However, real property must be exchanged for real property. Like-kind
propery is defined as property held for productive use in a trade or business, or for investment purposes, that is
exchanged for property which is also held for productive use in a trade or business, or for investment purposes.
Example, a vacant land which is held for investment purposes can be exchanged for retail property held for business
deferred exchange should be done through a qualified intermediary. A Qualified Intermediary is an independent third
party to the transaction whose function is to prepare the documents necessary to create the exchange, as well as to
act as the independent escrow agent for the exchange funds.
many can be saved through a 1031 Exchange for a next purchase?
If an investor is selling a shopping center for $1,000,000, and has a net adjusted basis of $500,000, the investor
will have a gain of $500,000 upon the sale of the property.
federal capital gains tax is 15% on the amount the property has appreciated in value. The investor will also pay a
tax known as depreciation recapture at the rate of 25% for the amount the property has been depreciated during its
ownership. In addition, there may be a state or local capital gains tax.
investors multiply the gain by 25% to get a rough estimate as to the amount of tax they might realize if they do
not structure the transaction as an exchange. In this example the gain would be approximately $500,000.
Accordingly, if we multiply this amount by 25% the estimated capital gains tax if this sale were not structured as
an exchange would be $125,000.
methods for 1031 Exchange Rental Property:
Identify three properties of unlimited value (Most Common Method)
Identify an unlimited number of properties whose aggregate fair market values do not exceed 200% of the value of
the properties sold in the exchange
Identifies more than three properties and their aggregate fair market value is in excess of 200%, the Exchanger
must purchase at least 95% of the value of the properties identified.
1031 Exchange Rental Property
Exchanger has 45 days from the date of the
sale of the first relinquished property to identify potential replacement property or properties; and a total
of 180 days from the original sale date to purchase the replacement property or properties.
Exchanger must acquire replacement property
of equal or greater value, obtain equal or greater debt on the replacement property, reinvest all the net
proceeds realized from the sale of the relinquished property, and acquire only like-kind
Exchanger must own the investment property
for at least one year before he can use it for 1031 Exchange.
4) Exchanger must initiate the 1031
process before the closing, once the closing occurs; it’s too late to utilize the 1031 deferred
Exchanger may use the vacation house or
primary residence for 1031 exchange as long as the property is reported as a rental or business use on the
tax returns for two consecutive years.
Advantage of 1031 Exchange Rental Property:
1) When selling real estate, if you sell and
reinvest, you will pay income taxes on the realized gain.
However, with 1031 exchange, you will defer the tax gains.
2) You may have management-intense rental properties and would prefer to
transfer your equity to ease-of-ownership
single tenant properties (coupon
clippers) such as Walgreen Drug Stores, Wal-Mart, Post Offices, 7- Eleven, Office Depot,
3) You may have been holding properties long after their appreciation has topped out. You can start rebuilding your
equity by disposing of those investments and acquiring new
4) You may have some non-income producing real estate investments, such as
raw land. You could exchange this property for another asset that would not only give you cash flow, but also get you income tax
deductions such as depreciation, which you did not have
with your raw land.
5) This means that more money is available for acquiring your next
investment. It can be regarded as a free loan from the government!
6) You may have owned a leveraged property long enough to have accumulated
considerable equity. You now have an opportunity to exchange into a larger
asset, and reposition your equity to your benefit or that of
your heirs, without paying taxes. We highly recommend using qualified professionals that have experience in
1031 tax-deferred exchanges to guide you and ensure your compliance with government
7) With proper estate planning you can keep exchanging properties throughout
your lifetime. Neither you nor your heirs will ever pay income taxes on the gains. By doing a tax-deferred
conserve your equity by not having to pay taxes on your net
Disadvantage of 1031 Exchange
1) Exchanger will have a slightly lower depreciation
schedule when acquire new properties. This is because
the IRS will look at the new tax basis as being the same as the previous one, less the
2) Exchanger losses on the income tax return cannot be
deducted if you exchange property rather than sell it. If
you want to take a loss, simply call it a sale, not an exchange.