A 1031 exchange, also known as the like-kind exchange, is a helpful tool and tax strategy for real estate investors that sell properties and buy replacement properties that are considered “like kind” in nature. Business owners of typical industries such as drug stores, fast-food restaurants, car washes, medical clinics, and more use the 1031 exchange to defer capital gains tax on the land that they own. With no restriction on the number of times you can use the 1031 exchange, ability to use the benefit between multiple states, and the potential to couple the benefit with other tax codes such as cost segregation depreciation and bonus depreciation, the 1031 exchange is tool real estate investors harness regularly.
A typical 1031 exchange occurs when a property held by a single owner or by tenants in common is sold through a qualified intermediary. The qualified intermediary opens an escrow account in which they hold all proceeds. The qualified intermediary sends in the required exchange documents for signature prior to all parties closing on the property. The identification period begins within the first 45 days after the property is sold, during which time the original seller must identify a replacement property. Finally, the exchange period commences within the first 180 days after the close of the sale property when the seller closes one or more of the replacement properties that have been identified previously. The main benefit of a 1031 exchange is the deferral of capital gains tax. By deferring paying capital gains taxes, investors can both delay paying taxes on their gains and can even elect to pass the property to heirs, giving them a step up in basis. While this tool is used by many within their business on the property that they own, a new proposal for change to the 1031 exchange could change the process of obtaining investment properties in a momentous way.
The real estate investment community has relied on the 1031 exchange since the early 1900s. There was an attempt to change the 1031 exchange in 2023 that fell through, but recently, our current legislation has proposed the 2024 budget to include a cap for 1031 exchange tax deferral. This would mean that investors would be less likely to invest in high value properties because of the lack of benefit by deferral. While there has been no set word on the outcome of the proposed FY 2024 budget plan yet, the debate will continue as to how the change to 1031 exchanges will affect the real estate community and the market as a whole. For questions regarding your commercial real estate purchase or sale, email me at firstname.lastname@example.org today!
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