For those thinking about selling investment property, the time may be right to take advantage of tax-deferred exchanges. Thanks to §1031 of the Internal Revenue Code, a properly structured transaction will allow an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gains taxes. Such a transaction is commonly referred to as a “tax deferred exchange” or a “1031 exchange.” Fortunately, the new tax law retained many of the benefits of 1031 exchanges, but there are changes that real estate investors should know.

Tax Law Changes

Despite attempts to eliminate or significantly restrict 1031 exchanges over the years, the new tax law that went into effect in January 2018 left 1031 exchanges in place with respect to real estate. However, they are now limited to real property exchanges and can’t be used to defer capital gains on personal property.

These changes can affect some real estate investors, particularly those who own property with significant value tied up in furniture, fixtures and equipment, such as restaurants. However, other tax provisions may help to offset those losses and may make real estate more attractive to investors. In addition, wealthy investors can also take advantage of the doubling of the estate tax exemption. By coupling 1031 exchanges with the estate tax exemption, potentially millions of dollars in capital gains can escape taxation permanently.

Of course, how the new tax laws will affect the overall real estate industry remains to be seen and there are always risks that further restrictions will eventually be placed on 1031 exchanges in the future. That’s why now is a good time to consider taking advantage of the law if you are looking to sell real estate investment property.

Requirements for a 1031 Exchange

In order to accomplish a successful 1031 exchange, there are three conditions that must be met.

  1. There must be an actual exchange, not just a transfer of property for money only.

Sale proceeds MUST be reinvested in other investment property and as part of the reinvestment, one property must be exchanged for the other, meaning that you must avoid receiving any of the sale proceeds or other property during the transaction. Any portion of the sale proceeds actually or constructively received will not qualify for §1031 treatment.

  1. The properties exchanged must qualify, and be of “like-kind.”

Like-kind is interpreted very loosely to mean virtually any real estate held for productive use in a business or for investment, whether improved or unimproved, can be exchanged for any other property to be used for productive business or investment purposes. So, if you sell an unimproved lot of land and purchase an improved one or vice versa, this still qualifies, just as selling industrial property and buying rental resort property does.

  1. The time requirements must be strictly followed.

There are 2 deadlines that must be followed: First, you must identify the new property to be purchased within 45 calendar days after the close on the sale of the old property. Second, you must close on the purchase of the new property within 180 calendar days from the closing date of the sale of the old property.

Assuming you meet these requirements, you can continue to defer taxes on your capital gains each time you exchange your property with no limit. This is especially useful since you can keep exchanging one piece of property for another one more likely to increase in value.

These are just some of the basics relating to structuring a proper 1031 exchange. If you or anyone you know is considering such a transaction, it is best to consult with an experienced attorney or tax professional as early into the process as possible, preferably at the time a party is first considering a sale, in order to ensure that all issues relating to the particular transaction are properly addressed.

To learn more about 1031 exchanges, read our related post Selling Real Estate? Is A Tax Deferred Exchange (1031) Right for You?