Exploring Real Estate’s 1031 Exchange
By Neil Sherman
I am often asked by current or prospective clients about (IRC Section) 1031 exchanges, especially by property owners who are considering a sale of an existing commercial property. Following last month’s article in the Quad Cities Business News, I received this email from Edward and Barbara G. of Santa Barbara, California, which basically asked this question, “Mr. Sherman, we recently traveled to Prescott and read with much interest your article on Due Diligence. As we are very close to selling one of our commercial properties, can you please give us some pointers on 1031 Exchanges? We have owned the property for the past 10 years or so, in case that makes any difference.”
For starters, I never give legal or tax advice, and always refer such clients to attorneys or CPAs who specialize in such matters. When it comes to exchanges, I have also referred many property owners to Jim Miller, senior vice president with Investment Property Exchange Services, Inc. (IPX1031) in Phoenix. He can be reached at 602-850-8630 or email@example.com. Jim is arguably one of the top 1031 Exchange experts anywhere; he has forgotten more about the subject than most people in that industry know. IPX1031 is a fully owned subsidiary of Fidelity National Financial, which owns seven large title companies and is one of the largest and strongest title insurers in the country.
Seeing as how my office and I have successfully handled dozens of 1031 transactions through the years as the broker of either one or both “legs” of the transaction, here are a few things to consider for Edward and Barbara, or anyone else in a similar situation. Before you transfer the property you are selling (the “Relinquished Property”), you need to enter into an Exchange Agreement and Assignment Agreement with a Qualified Intermediary (“QI”) or Accommodator, and the entire NET proceeds need to be immediately transferred to such QI directly from the title company. If this does not happen at the closing, or if you take possession of the proceeds in the interim, then effectively you have blown the exchange and will no longer be entitled to the tax benefits of such a transaction.
Next, you will have 45 calendar days from the date of closing to identify, in writing, your prospective “Replacement Properties,” meaning that list of properties that you have determined to be a good fit for your Exchange, and from which you will ultimately select one or more to purchase. There are certain rules governing the definition of what is “like kind,” how many properties you can identify, and the aggregate purchase prices of those properties, just to name a few, so further advice from a QI or similar professional is highly recommended.
Following the 45-calendar day identification period, you will have an additional 135 calendar days to acquire (close escrow on) the Replacement Property(ies). If you do not reinvest the total net proceeds from the Relinquished Property into the Replacement Property(ies), any amount not reinvested will be considered “boot,” or taxable income to the taxpayer.
Likewise, if you do not replace the exact amount of debt (unless the previous property was owned free and clear) from the sold property into the new property, the difference in debt will be treated as “debt forgiveness” and will also be taxable to the taxpayer.
This rather short article cannot possibly address every single situation to consider when entering into a 1031 Exchange, such as the “taxable basis” from the Relinquished Property, or such topics as “Reverse Exchanges,” but we stand ready to help any QCBN readers who are considering the sale of a commercial property, followed by a 1031 Exchange into a new property.
If handled correctly and strictly by the book, a 1031 Exchange can be a fantastic way to continue buying and selling commercial properties years into the future, all the while deferring the capital gains taxes from each sale and rolling that additional capital into subsequent acquisitions.
More information and videos about 1031 exchanges can be found on IPX1031’s website: www.ipx1031.com.
Neil Sherman is the Designated Broker and Managing Director of Sperry Commercial in Phoenix, and can be reached at 602-566-7210 (direct).
Please send all commercial or multifamily property-related questions to firstname.lastname@example.org