If you are preparing to sell an investment property, it is important to take a moment to evaluate your options for minimizing tax burden. In a traditional sale, the owner of the property needs to pay taxes based on the calculated capital gains. On the other hand, a 1031 commercial property exchange might be a useful strategy to defer the taxes and minimize immediate out-of-pocket costs.
What is a 1031 Commercial Property Exchange?
This exchange is done when the equity from an investment is rolled into another like-kind property. These exchanges are only applicable to business transactions and investments; they cannot be used with a personal residence or vacation home.
Instead of selling the property and putting the cash in the bank, the money can be held in an escrow account. The investor has 45 days to identify the property or properties that will be purchased as a replacement for the original property. Then, the new purchase needs to be finalized within 180 days of the sale of the first property.
It is important to make sure that the replacement property is equal or higher in value compared to the original property. If the new property is priced lower than the original, then the leftover money is subject to capital gains tax calculations.
By transferring the money into the purchase of another property, investors can avoid paying the high costs associated with short-term and long-term taxes on the appreciation. A 1031 commercial property exchange keeps the money in the investment property and away from your bank account so that you don’t have to pay the taxes on the appreciated value right away.
Rules for 1031 Exchanges
Like all real estate transactions, specific rules are in place to regulate the way these exchanges can be completed. If you are working on the implementation of a tax-deferment strategy, then it is essential that you hire the assistance of an accountant and real estate financial expert who can assist with your transactions.
Examples of 1031 rules include:
- Similar Exchange: The original property and replacement property need to be a like-kind exchange, meaning that they are similar in value. It is simplest when the equity is similar between the two.
- Timing Requirements: As mentioned above, the 45-day and 180-day rules apply to the timing of the purchase of the new property after the first asset is sold.
- Title: The name on the title of the first property needs to match the name on the title of the replacement property.
- Facilitator: It is common for a facilitator to be involved in the transaction to ensure that everything matches the requirements for the exchange.
We have an article that goes more deeply into 1031 exchange rules if you are interested in learning more about them
If you are still learning about commercial properties and investments, then you might not understand the nuances of the tax-deferment strategies that can be used. The best thing that you can do is talk to an industry expert for advice about a 1031 commercial property exchange. First National Realty Partners is here to answer your questions and help with your investment strategy. Call our team right away for more information about the services that are offered.