Should I consider a 1031 Exchange?

This is a question many Sellers of investment real estate wrestle with.

For those readers that don’t know about the 1031 tax-deferral tool, let’s do a quick review. IRS Section 1031 allows real estate investors to sell an investment or business property and reinvest the proceeds into a new “like kind” property, while deferring recognition of capital gain and, potentially, depreciation recapture. Both the relinquished and replacement properties must be real property held for investment or productive use in a trade or business. “Like-kind” is broader than many people assume. It does not mean exchanging apartments for apartments or an office building for another office building. An investor may sell an office building and acquire vacant land, a warehouse, apartments, a retail building or another qualifying real estate investment.

There are pros and cons to the question of whether a 1031 exchange is a viable option. The primary advantage is the ability to keep more equity invested rather than using a portion of the proceeds to pay current taxes. That additional capital may help an investor acquire a larger property, improve cash flow, diversify a portfolio or exchange a management-intensive asset for one better aligned with future goals. By reinvesting money that would have gone to taxes an investor could possibly increase their returns and increase their wealth faster.

The requirements, however, are strict. In a typical delayed exchange, an investor generally must identify potential replacement property within 45 days and complete the acquisition within 180 days, subject to the applicable tax-return deadline. The seller also cannot take actual or constructive receipt of the proceeds; a qualified intermediary is commonly engaged to hold and transfer the funds. Missing a deadline or mishandling the proceeds can disqualify the exchange.

The key question is whether the potential tax deferral outweighs the additional costs, restrictions and pressure involved. Investors should consider the estimated tax liability from an outright sale, the availability of suitable replacement properties, financing needs, expected returns and whether they need access to any of the proceeds.

A 1031 Exchange can be a very valuable tool, but the options and rules must be thought through prior to going to the closing table. I advise clients that consider any type of sale of investment or business property to meet with qualified advisors well in advance of even starting to market their property. Hasty decisions can be very costly.

Loyd Robbins is a lifelong Sarasota resident with 53 years of experience in commercial real estate and business brokerage. Trusted advisor to owners navigating meaningful transitions.