Some Benefits of a Tax Free Exchange

The main benefit of a tax-free exchange is just that–freedom from a tax. The gain that could be realized by one or both of the principals in the exchange transaction does not need to be recognized at the time of the closing. The gains tax is deferred until the property owner makes a taxable disposition of the new property at some later time.

It takes more patience and hard work to set up an exchange than it does to arrange a straight purchase and sale of real estate. Some property owners and their agents simply do not understand the benefits of an exchange or are worried about the strict requirements imposed by the Internal Revenue Code.

Owners need to know that the 1031 Exchange is just another tool like a purchase, sale, option or lease.

The real estate exchange has become a normal business tool used by investors, corporations and business owners throughout the country. If you have not used this tool, you may have already paid too much in taxes.

The benefit from the tax postponement is apparent. The owner can reinvest the full equity in other property, including gains, without any decrease in value due to tax payments. In effect, the government extends an interest-free loan to the investor, who then is able to obtain leverage over and above that obtained from regular mortgage financing.

An example is a trade up to a larger income property.

An investor owns a 10-unit apartment building that is too small for an on-site manager. The income is desirable and a sale would be costly because of a large gain. The equity could be exchanged up into a larger apartment property that would adapt to professional management. The larger property would have increased income to cover the bigger loans and management fees. After the transaction the owner can have the same or higher income, hire a professional property management company and be relieved of management problems.

“Like-Kind” Property

To qualify as a 1031 exchange, the property being sold and the property being acquired must be “like-kind.”

The Like-Kind Property Definition is a very broad term which means that both the original and replacement properties must be of “the same nature or character, even if they differ in grade or quality.” In other words, you can’t exchange farming equipment for an apartment building, because they’re not the same asset. In terms of real estate, you can exchange almost any type of property, as long as it’s not personal property, it must be an investment property.

Some examples of types of exchanges that would be allowed

•  Exchanging a duplex for an apartment building.

•  Exchanging a single family rental property for a commercial office building.

•  Exchanging a rental property or vacation rental for a warehouse.

•    Exchanging a single-family rental property in Nevada, you could exchange it for a commercial rental property in Texas.

There are strict rules that must be followed to make a real estate exchange, and the original replacement property must be within the U.S. to qualify under section 1031.

Let’s get together to evaluate your present portfolio of properties and review your plans for future acquisitions. A real estate exchange might be something that you may want to consider in the future.  o