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 property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment”.
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.
A portion of monthly income may be offset by depreciation.
Investors seeking more current income can 1031 exchange from non-income producing or under-performing assets into one or more high-quality properties that may generate monthly income. 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.
A tax-deferred 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).
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.
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 1031 Exchange from raw land or residential rentals into large, Class A properties with credit tenants, professional management. and better long-term appreciation potential.
We’ve heard nightmare stories over the years concerning the management headaches that come with rental properties: properties that have depreciated in value, and that would have huge tax consequences if sold, with the IRS taking a big chunk.
However, these hassles have solutions. One solution is to transfer the money via a 1031 Exchange into a portion of larger properties, avoiding capital gains, thereby, still having rental income from properties that don’t require active management.
Michael Malone,FRG Vice President
Is a Tax-Deferred Exchange right for you? Sure, a 1031 Exchange provides an effective strategy for deferring the capital gains tax that may arise from your investment property sale. But, beyond Capital Gains deferment, there are other reasons to participate. A 1031 Exchange can relieve the burden of active real estate ownership and can allow the diversification of real estate portfolios by geography and property type, giving access to multimillion dollar properties.
Ben DiSalle,FRG Vice President
Is a Tax-Deferred Exchange Right for You
Taxes on the disposition of real estate or other capital assets are paid on capital gain, not equity or profit. It is possible to sell property without realizing much profit and still owe substantial capital gains tax. Capital gains is simply the difference between the sales price and the adjusted basis (i.e., what you paid for the property, plus amounts spent on capital improvements, less depreciation taken) less any closing costs associated with the sale.
The calculate your estimated capital gain – first subtract the adjusted basis from the sales price; then subtract the costs of your transaction commision, fees, transfer tax, etc; finally multiply the capital gain by your combined tax rates (Federal and State) to determine your estimated capital gain tax.
To fully defer state and federal capital gain taxes, the Exchanger must reinvest all exchange proceeds and either acquire property with equal or greater debt or reinvest additional cash equal to the debt relief. The following worksheet is a useful tool for determining the amount of cash and debt that should go into the replacement property.
Do you have questions? If it’s time to restructure and simplify your real estate portfolio, we can help you take the next step.
The information contained herein is neither an offer to sell nor a solicitation of an offer to buy securities. Do not construe the contents and discussion herein as legal, tax or accounting advice. The information contained herein is believed to be accurate, however, no such warranties, representations, or guarantees are provided to that effect, either expressly or implicitly, further, the information contained herein is intended only to provide a high level overview and not an exhaustive explanation of the rules, regulations, exceptions, etc. generally applicable to a like-kind exchange pursuant to Internal Revenue Code Section 1031. The discussions and examples contained herein are based on law presently in effect and certain proposed Treasury Regulations. Nonetheless, readers should be aware that new administrative, legislative or judicial action could significantly change the information contained herein. Transactions involving Internal Revenue Code Section 1031 are highly complex, and it is strongly recommended that investors seek competent, independent tax and legal counsel prior to initiating, and while performing, such a tax deferred exchange.