P.O. Box 2869, Jackson, WY 83001
Do you have a property that you’re selling? Did you rent it out, run your business out of it, lease it, or is it raw land? As long as it is not your primary residence, it is a viable 1031 property! What are you going to do with the money resulting from the sale? If you want to reinvest in real estate, your new property will most likely qualify for a 1031 Exchange.
What is a 1031 Exchange?
Section 1031 of the IRS tax code allows for the sale of the property that you own, exchanging it for a like-kind property, and deferring capital gains tax on the sale in order to transfer that money into a new investment property- essentially a tax break. As investors grow their portfolio and acquire more investment properties, if they decide to sell a property, the investor would have to pay capital gains tax on their earnings, which could be as high as 20%! Capital gains tax is a tax paid by an investor upon selling their asset based on the amount of money the asset appreciated during the time it was held. A 1031 Exchange is not a buy and sell deal, but it is a swap of one property for another. And because you are swapping instead of selling and buying, it allows for capital taxes to be deferred that would otherwise have to be paid at the time of the sale. The 1031 Exchange was written by congress to allow anyone who meets all the requirements to sell their property and defer paying taxes in order to invest that money into another property.
Let’s say you purchased a shopping center 10 years ago for $450,000, and today the center is now worth $1,250,000. If you sold it and cashed out, you would have to pay a Capital Gains Tax (CGT) on the $800,000 you gained. The CGT could be as high as 20%, meaning you would have to pay $160,000 to the government. However, through the 1031 exchange there is opportunity to keep that $160,000 by identifying a new asset to invest it in.
Need to Know Basics
Let’s keep in mind the three basic guidelines for tax deferral:
- Purchase for equal or greater in value (relinquished property sales price minus closing costs).
- Replace any debt that you are relieved of on your sale with new debt, or cash for your purchase.
- Spend all of the cash proceeds received from your sale on your purchase.
What are the requirements of a 1031 Exchange?
- Primary residents do not qualify for a 1031 Exchange
- Properties must be held for business or investment purposes
- Both properties must be within the United States
- Must use a Qualified Intermediary (QI)
- Your Qualified Intermediary cannot be someone with whom you’ve had a business or family relationship with. Your QI cannot be your broker, friend, attorney, accountant or sibling.
- Both properties do not need to be similar in grade or quality but must be like-kind properties
- According to the International Revenue Services, “Properties are of like-kind if they’re of the same nature or character, even if they differ in grade or quality. Real properties generally are of like-kind, regardless of whether they’re improved or unimproved. For example, an apartment building would generally be like-kind to another apartment building. However, real property in the United States is not like-kind to real property outside the United States.”
- To qualify as a like-kind exchange, the property must be both (1) qualifying property, and (2) like-kind property.
2. Equal or Up Investment
Section 1031 stipulates that in order to defer 100% of the taxes on your gain on the sale of the old property, you must buy equal or up. There are two aspects of the equal or up rule. First, you must reinvest all of the cash that is generated from the sale of the relinquished property. Second, you have to buy a property (or properties) that has a sale price equal to or greater than the net sale price of the property you sold. Here is the IRS’s fact sheet on 1031 Exchange: https://www.irs.gov/pub/irs-news/fs-08-18.pdf
Rules and Timeline of a 1031 Exchange
- Replacement property should be of equal of greater value to the one being sold
- Replacement property must be identified within 45 days
- Replacement property must be purchased within 180 days
Your exchange timeline starts on the date your relinquished property closes and records. From that day, you have 45 days to identify the property/ies you would like to purchase, and 180 days to have the exchange completed. If you sell more than one property, your timeline starts with the first relinquished property.
- If you do not identify a property on your 45th day, you will have a failed exchange and we can return your sale proceeds on your 46th day.
- If you do identify and do not purchase, you will have a failed exchange. We can release your sale proceeds on your 181st day.
1031 in a Multifamily Building
What is a TIC (Tenants in Common) Structure?
In a Tenants in Common (TIC) Structure, each of the co-owners gets an individual deed at the time of closing reflecting his or her undivided percentage interest in the entire property. It is basically where two or more individuals own a property together, but with separate and distinct shares. 1031 Exchangers have found a lot more favor with TICs because they have found it is nearly impossible to find a replacement property in the strict and quickly approaching deadlines given by the IRS (45 days to find a replacement property). Using a TIC gives investors a lot more flexibility and diversification.
You sell a small apartment building you’ve owned for 10 years and your equity is $500,000. Depending on any debt you still carry on the property, you could probably purchase a new investment of around one million dollars. While that may seem like a lot of money to work, there is a chance that you still could not qualify to purchase an A-class property on your own. Investing that $500,000 in a TIC, though, could get you a million-dollar interest in an institutional grade property.
Using a TIC you could become a passive investor in an apartment building, luxury hotel or resort, office complex, or medical facility. This diversification could potentially assist you in reducing risk and increasing the value of your portfolio. Additionally, it could also get you into a C or B class “heavy lift” value add project, without you having to do the heavy lifting. So you can realize the forced appreciation that these types of projects can offer without having to do the work. Instead, the full time professional asset management team is working to implement the business plan, while you enjoy the resulting increase in value of the asset.
Q: Can I 1031 from a medical building to a multifamily building or vice versa?
A: Short answer- yes. Properties that are of like-kind can be 1031’d. Real properties generally are of like-kind, regardless of whether they’re improved or unimproved. So, it can be a medical building, single-family home, multifamily apartment building, raw land, self-storage facility or any other investment real estate. The type doesn’t matter so long as it is held for investment or business purposes. However, real property in the United States is not like-kind to real property outside the United States.
Q: Can I 1031 my profits from a syndication into the next syndication deal?
A: Short answer- yes. To do this, all members need to invest together into the next property or their interest would need to be bought out by the GP prior to sale. It can be a bit complex for GP sponsors to facilitate, so if this is something you want from your syndicators, you need to inquire in advance with your sponsors to verify that they intend to 1031 forward.
Q: How do I bring funds from a 1031 Exchange sale into syndication?
A: This can be done through a process called TIC- Tenants in Common. But your investment would need to be large enough to justify the additional cost and paperwork. Through the TIC structure, the 1031 investor partners up with the syndication in a share of the ownership and takes direct title to the property, which is one of the key requirements of a legitimate 1031 exchange.
Q: What if I decide to not 1031 into another property?
A: Then you will pay taxes on the capital gains for the investment you just exited as well as the deferred taxes from the previous property that you 1031’d. If instead, you continue to 1031 until you pass the property to your heirs, the property steps up on the basis upon your passing—and your heirs will owe no taxes up to a certain amount under current tax structure. All of the deferred taxes go away. Feel free to
Q: What does the life cycle of a 1031 Project into a TIC look like?
A: Typically, 1031 investors may be more concerned about their tax savings than they are in investing in solid projects that have long-term earnings potential as well as tax benefits. Thankfully, we are able to provide a project that will not only meet the tax savings goals of investors but which also has tremendous upside potential. We make easy for anyone wanting to use 1031 funds for the acquisition because we enter into a Co-Ownership Agreement with the 1031 person/entity that allows Prime Investment LLC to manage that asset for them as if they were a passive investor. During the period of ownership, the 1031 person/entity will receive distributions according to the Co-Ownership Agreement.
Q: As a TIC owner, am I not an active investor?
A: The responsibilities for a TIC owner are set out in the Co-Ownership Agreement. Prime Investment LLC endeavors to make it as stress-free and painless as possible for each TIC owner by requiring Prime Investment LLC and not the TIC owner to be the day-to-day asset manager of the property. This allows a TIC owner to have greater peace of mind knowing that another co-owner is tending to the day-to-day business of the property.
Q: What else should I know before going into a TIC Structure?
A: The 1031 Exchange rules and processes are complex and very well defined. It is highly inadvisable for anyone to try and navigate that process by themselves. As such, everyone looking to use a 1031 on this or any future property must hire a Qualified Intermediary who will walk with you step by step through the process and ensure that your 1031 exchange is compliant.
The 1031 Exchange is a useful tax-deferring strategy that allows for+ the build up of wealth. Although an intricate process, when done correctly and with the help of experienced professionals, it is well worth the time and work. At Prime Investment we do all we can to save as much of our hard earned money as possible for our investors- this includes taking advantage of all the available resources set before us. Have any more questions? Schedule an appointment with us here: https://primeinvestmentllc.com/contact/