The 1031 Exchange

The 1031 exchange may be the single greatest tool available to the average American real estate investor when it comes to growing one’s equity.

Generally speaking, a 1031 Exchange refers to Section 1031 of the tax law. In essence what this law says is that if you have an income or investment property you may sell this property and buy another without paying any capital gains. Moreover you may use this vehicle again and again as many times as you like, in fact indefinitely, as long as you never completely “cash out”.

Section 1031 goes on to say that this is a tax-deferred “like kind” exchange. Many people take all of this language too literally. Let’s take a look.

1. A 1031 exchange is complicated because I have to find someone else who is willing to exchange property with me. NO. The term exchange does not mean that you have to literally trade properties with someone. In a 1031 Exchange you will sell your property and then roll the proceeds of that property into a new property while deferring any capital gains taxes.
2. In a 1031 exchange If you own a multifamily you have to exchange into another multifamily to qualify. NO. Like kind in this case is taken much too literally. A 1031 like-kind exchange has to do with what essentially boils down income or investment property, not just real property. For example if you have a commercial airplane and you want to sell that and for some reason you have capital gains on it you can buy another airplane, the same applies to various industrial equipment. The like kind exchange says that you have to exchange into more real property.

Examples

You own a piece of land in New Hampshire that you have held onto as an investment and that you have treated as such, meaning you did not just buy it and then subdivide but in fact held it. You believe it’s time to start receiving income. Provided your circumstances fit the bill, you can sell this non-income producing parcel and roll your proceeds into a multi-unit residential property, a strip mall, an office building, or one of the various hand-free real estate products we offer.

You’ve own a multi-unit residential property in Boston and you’ve had it for some time. Your equity has begun to outstrip your income - meaning that you own such a significant piece of it that you could be making more money else where with more leverage. Additionally you are considering retiring in the not-too-distant future. Under the right circumstances and with a little planning you could buy a second home that someday you’ll retire to or you could trade up into a bigger better safer commercial property like we offer through our partners

Be Careful

Timing and property situation and use specifics are VERY important in a 1031 exchange. You will require the services of a QI or Qualified Intermediary. Additionally you should seek the counsel of both an attorney and a real estate professional to help you determine what will qualify and what won’t, but moreover to help you determine the soundness of the decision from a financial perspective.