Walter & Shuffain - Certified Public Accountants & Business Advisors

What is a 1031 Exchange and Who Can Benefit from One?

Author: Eric Gashin, Shareholder

The opportunity to defer tax is music to the ears of many. One option for those in the real estate industry is a 1031 exchange, also known as “Starker exchange” or “Like kind exchange.” Investors who sell a property and then purchase a “like-kind property” with the profit gained are permitted to defer capital gains taxes. The benefits of a 1031 exchange go beyond deferring tax. Investors who want to relocate their investments, or who wish to shift the focus of their business can exchange businesses for others that are a better fit without paying a significant amount of tax.  In this article, we’ll discuss the different types of 1031 exchanges and the potential benefits for each.

Types of 1031 Exchanges for Real Estate

Originally, the 1031 exchange was designed to allow a direct exchange between two parties. A simultaneous exchange means the investor relinquishes and closes on the replacement property on the same day. Simultaneous exchanges aren’t as common anymore because it’s rare to find a property owner who owns the exact piece of property you want and wants the exact property you own. It’s not out of the question but isn’t very likely.

The most common type of 1031 exchange would be the delayed like-kind exchange. In this scenario, a middleman is needed to hold the cash from the sale of the property and then uses it to purchase the replacement property.  Investors are given 45 days after the sale of their property to identify replacement property and 180 days to close.

With a reverse exchange, you purchase the property first and pay later. The stipulation with a reverse exchange is it must be a cash purchase, and banks customarily won’t allow loans when you’re listed on both the relinquished and the replacement property. There are ways around this dilemma, including creating an LLC and putting the replacement property title in the LLC’s name. After the original property sells a title transfer can then take place.

If the property you’re selling is worth more than the property you wish to buy, a construction/improvement exchange may be an option. The remaining funds are then used to build or improve the property you want to buy instead of paying tax on the difference.

Real estate experts feel there is no better time for investors to consider property exchanges. For those considering a 1031 exchange, the rules regarding each of the exchange options are vast and complicated. Seeking the advice of an experienced CPA that specializes in real estate is important to plan the strategy and protect your tax dollars.

Please note Congress passed the Republican tax reform bill, HR.1, the "Tax Cuts and Jobs Act" on Wednesday, December 20, 2017 and President Donald Trump signed the bill into law on December 22, 2017. The legislation will take effect January 1, 2018.   Section 1031 like-kind exchanges for real estate are preserved under current law. However, exchanges of personal property assets are eliminated.

Contact Eric Gashin or any other team member at Walter & Shuffain for help with your 1031 exchange.