Section 1031 Exchange Assessments

Among the most powerful tools to defer gain on the sale of real estate held for investment or used in your trade or business are 1031 exchanges, also called “like-kind exchanges” or “deferred exchanges.”

Every 1031 exchange presents a unique set of facts and you should consult a tax professional if you are considering this option. Weaver’s real estate tax professionals will take a customized approach to your situation, developing a thorough understanding of your transaction goals, working with you to maximize tax savings.

Here are some answers to basic questions you may have:

What types of property qualify for deferral in a 1031 exchange?

Only real property (or interests in real property) held for investment or used in a trade/business are eligible for 1031 exchange deferral. (The rules regarding qualifying property changed with the 2017 Tax Cuts & Jobs Act.) 

What are the basic types of 1031 exchanges?

The three most common exchange types are:

  • Forward Exchange: Sale of relinquished property followed by acquisition of replacement property
  • Reverse Exchange: Acquisition of replacement property followed by sale of relinquished property
  • Improvement Exchange: Construction/improvement of replacement property to be acquired followed by sale of relinquished property

To defer gain in a 1031 exchange, how much of the proceeds from a sale of real estate must be reinvested?

To defer 100% of the gain on the sale of real estate, you must exchange value for value and re-invest 100% of the proceeds in replacement property. Any un-reinvested proceeds are referred to as “boot” and may be recognized as taxable income. Debt-financed transactions present a further complication.

What are the identification and exchange windows in a Forward Type 1031 Exchange?

An exchangor must identify the replacement property to be acquired within 45 days of selling the relinquished property and acquire the replacement property identified within 180 days of selling the property given up (the relinquished property).

What are the identification and exchange windows in a Reverse Type 1031 Exchange?

An exchangor must identify the relinquished property to be disposed within 45 days of acquiring the replacement property and dispose of the relinquished property identified within 180 days of acquiring the replacement property identified.

How many properties can I identify?

During the 45-day identification window, you can use any of the following rules to identify replacement property in your 1031 exchange:

  • 3 Property Rule: Any 3 replacement properties without regard to their fair market value; or
  • 200% Rule: Any number of replacement properties so long as their aggregate fair market value of all replacement property does not exceed 200% of the aggregate fair market value of all relinquished properties; or
  • 95% Rule: Any number of replacement properties without regard to the combined fair market value, as long the replacement properties actually acquired amount to at least 95% of the fair market value of all identified properties.

 

EXPERIENCE IN ACTION | Section 1031 Success Story

Identifying the opportunity

Unable to find a suitable build-to-suit location for warehouse expansion, Weaver’s client (Partnership A) proposed to liquidate an existing industrial campus and build-out undeveloped land owned by a related partnership (Partnership B). Weaver identified the opportunity to defer gain recognition through a Reverse Section 1031 Improvement Exchange. The projected gain on the sale was $10 million.

A customized solution

Weaver’s strategy utilized a 30-year, market rate ground lease between an Exchange Accommodating Titleholder (EAT) and Partnership B. Upon execution of the ground lease, the EAT utilized a construction loan to complete the new facility. Within 180 days of breaking ground on the new facility, Partnership A sold its existing industrial campus and transferred the proceeds to a Qualified Intermediary (QI). The QI transferred those proceeds to the EAT in exchange for the new facility and the subject ground lease. The new facility and ground lease were subsequently conveyed to Partnership A. The entire transaction was covered under current guidance governing Reverse Section 1031 Improvement Exchanges.

Value added impact

Weaver’s relationship value and proactive planning helped lead to a favorable outcome in which the client was able to achieve tax savings of more than $2 million, enabling the client to expand its capacity. The overall result? More community reinvestment and job creation.

 

For more information on Section 1031, check out these resources:

Sam Wren

Sam Wren

Partner-in-Charge, Business Tax Quality and Risk Management

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Sam Wren, CPA, has more than 25 years of experience in tax planning and compliance for partnerships, corporations and individuals…

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