1031 Exchange Explained

Irs Section 1031 allows a real estate investor of commercial real estate to exchange commercial real estate and defer paying federal and state capital gain taxes (20%+ applicable state taxes) in the event that they purchase a like-kind commercial real estate. A tax-deferred exchange is a method by which a real estate investors trades one or more relinquished commercial real estate for one or more replacement commercial real estate 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 real estate allows real estate investors not only to defer their capital gains taxes, but to also upgrade their commercial real estate into larger, institutional-grade commercial real estate. Essentially, 1031 exchanges allow real estate investors to use all of the proceeds from their sale as leverage to gain access to more valuable commercial real estate.

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

1031 Exchange Rules

1031 Identification Rules

1031 Exchange Rules require real estate investors to identify like kind commercial real estate for replacement within 45 days of the close of escrow on the relinquished commercial real estate. Furthermore, all replacement commercial real estate must be acquired within 180 days of close on the relinquished commercial real estate. All 1031 exchanges must comply with one of the follow three rules:

The Three-Commercial Real Estate Rule - This rule allows the exchanger to identify up to, but no more than 3 potential commercial real estate as qualified replacement commercial real estate within the allotted time frame.

The Two Hundred Percent Rule - In the event that three or more like kind commercial real estate serve as replacement commercial real estate, the aggregate value of said commercial real estate can not exceed 200% of the value of the commercial real estate sold.

The Ninety-five Percent Exception - Finally, in the event that rules 1 and 2 do not apply to the exchange, the Ninety-Five Percent Rule takes precedence. This rule dictates that the aggregate value of the acquired commercial real estate must account for at least 95% of the value of the relinquished commercial real estate when sold. This means that in order to engage in a 1031 exchange, foregoing all capital gains on the transaction, the real estate investor must reinvest at least 95% of the proceeds involved in the transaction.

Many 1031 exchangers prefer buying commercial real estate as tenancy in common because of the ease of completing the transaction and closing on commercial real estate.

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