1031 Exchange Explained

Internal Revenue Code allows a property owner of commercial property to exchange commercial property and defer paying federal and state capital gain taxes (20%+ applicable state taxes) in the event that they purchase a like-kind commercial property. A tax-deferred exchange is a method by which a property owners trades one or more relinquished commercial properties for one or more replacement commercial properties of like-kind, while deferring the payment of federal income taxes and some state taxes on the transaction.

Completing a 1031 exchange with a tenancy in common interest ownership in a commercial property allows property owners not only to defer their capital gains taxes, but to also upgrade their commercial property into larger, institutional-grade commercial properties. Essentially, 1031 exchanges allow property owners to use all of the proceeds from their sale as leverage to gain access to more valuable commercial property.

If you are thinking of transferring any commercial property, contact us today for more information on 1031 exchanges.

1031 Exchange Requirement

To fully defer all capital gains taxes, all 1031 exchanges must meet four separate requirements:

First, 100% of all proceeds from the sale of the first commercial property must be reinvested into the second, replacement commercial property.

Second, the amount of equity ( commercial property value minus loan value) of the replacement commercial property must be equal to or greater than that of the relinquished commercial property.

Third 1031 Exchange Requirement: By law, you must use an independent third party, called a Qualified Intermediary, to hold the proceeds of the sale. The Qualified Intermediary also will prepare the legal documents required to link together, as a qualified exchange, the sale of the old commercial property and the purchase of the new commercial property.

Fourth 1031 Exchange Requirement: exchanged commercial properties must be like kind. For a commercial property exchange this means real-commercial property for real-commercial property, but not necessarily land for land or a rental house for another rental house.

It is often difficult in the short 45-day time frame to locate a commercial property that has the right purchase price, debt ratio, and closing schedule to meet the 1031 Exchange Requirements-and then arrange any financing that may be necessary. Because there is a steady supply of tenancy in common commercial properties available they are an ideal solution for exchangers seeking management free 1031 properties with steady income.

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