Frequently Asked Questions
A 1031 Exchange is a transaction in which a taxpayer is allowed to sell one property and buy another without a tax consequence. This can be done through a simultaneous or delayed 1031 exchange. The transaction is authorized by Section 1031 of the IRS Code. It is the best strategy for the deferral of capital gains tax that would ordinarily arise from the sale of real estate.
A successful exchange results in the taxpayer being able to utilize 100 of the proceeds from the sale of property, thereby deferring capital gains taxes.
Real estate owners can accomplish virtually any objective with 1031 exchanges, including greater leverage, diversification, improved cash flow, geographic relocation, and/or property consolidation..
Section 1031 of the tax code provides one of the best strategies for the deferral of capital gains taxes, which would ordinarily arise from the sale of real estate. Exchanging defers the recognition for the capital gains tax, leaving the property owner with substantially more proceeds to purchase a replacement property. The tax code states, No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment purposes if such property is exchanged solely for property of like-kind, which is to be held for other productive use in trade or business or for investment purposes.
Many still believe that you must swap two properties. Although this was required in the original code, this is rarely done in present times.
Many believe only investors of large commercial properties can utilize the benefits of Section 1031. The great thing about 1031 Exchanges is that it applies to all investment properties, large and small. It will work the same way for a corporation selling a large shopping center as it would for an individual selling a single family home used as a rental property in a vacation area.
Many believe you Must acquire a property of similar uuse or services.: While 1031 exchanges are also known as "like-kind" exchanges, like-kind simply applies to real property held for business use or investment. Therefore, an investor may sell raw land and acquire a 5-unit apartment building or sell a warehouse and acquire raw land. He can sell one property and acquire three or sell four and acquire one. Virtually any type of real property used for business use or investment will qualify.
Many believe that doing 1031 exchanges are so complicated they are not worth doing. The fact is that when working with the right qualified consultants who specialize in 1031 tax deferred exchanges, the exchange process is very simple. They will keep you aware of your time deadlines, get your through to the right qualified intermediaries, attorneys, CPA's and commercial lenders.
The exchanger will have more buying power because the federal income taxes are deferred. This will enable him to leverage himself up greater than he could had he paid the tax liability. The additional equity to reinvest will make him a more solid buyer and help him get easier financing.
Investors can do exchange after exchange to create a pyramiding effect. This tax liability is forgiven upon the death of the investor as the heirs get a stepped up basis on the inherited property.
The exchanger will have greater selling power because he does not have to inflate the sales price to cover some of the capital gains that would normally be due upon the sale of an investment property. It will enable him to be more flexible with the selling price. The exchanger can acquire a replacement property with greater income potential. He can sell raw land and acquire income producing property. Perhaps, the investor wants to acquire a building with additional units or in an easier to rent location. The Exchanger has the opportunity to consolidate several hard to manage properties or diversify several small properties into one large property. It provides an excellent opportunity to relocate or expand a current business or investment. An exchange can also help an investor acquire a less management intensive property.
- Estate preservation
- Increased buying power because of greater cash flow
- Increased selling power because the federal capital gain tax liability is deferred
- Exchange for property with an increased income (more rental units, higher rental income per unit, lower operating expenses, easier to rent location, etc.)
- The need or desire to relocate a business or investment property exchange for property that requires less management
- Exchange for property that is easier to finance
- Consolidate smaller properties into larger property
- Diversify a large property into smaller properties
- The need or desire to expand a business into a larger space
All of the above culminates into one significant power-The ability to create pyramiding wealth accumulation in real estate ownership. Slight Disadvantage-The basis of your replacement property will be lowered by the amount of gain deferred on the sale of your relinquished property. However, when weighing this against the deferred gain, the astute investor can clearly see they are still significantly ahead.
Relinquished property: The relinquished property is the property the exchanger owns and wants to sell via the 1031 exchange.
Replacement Property: The replacement property is the business use or investment property the Exchanger wants to acquire to complete the 1031 Exchange. There can be more that one of each of the relinquished and replacement properties. For example, and Exchanger can sell three small properties and purchase one large property or sell one large property and acquire four smaller ones. An exchanger does not have to purchase the same type of property. For example, he can sell a storage facility and acquire an apartment building or sell a raw piece of land and acquire a shopping center.
Exchanger: the taxpayer who is electing to defer the capital gains by effecting a 1031 exchange
Seller: The seller is the person who owns the property the Exchanger wishes to acquire as a replacement property.
Buyer: The buyer is the person who wants to purchase the property the exchanger is selling.
Qualified Intermediary (QI): The use of a qualified Intermediary is required by the regulations of Section 1031. One of the safe harbors of the regulations is the use of a qualified intermediary to facilitate the exchange. The sale of the relinquished property and the acquisition of the replacement property must.
NNN Lease (Triple NET): Tenant is responsible for all CAM, Taxes, and Insurance. Landlord is responsible for roof & structure, occasionally parking.
Absolute NNN Lease: Tenant is responsible for all expenses including roof & structure. However, Lease can be cancelled for certain acts of GOD.
Bond Lease: Same as Absolute NNN except Tenant is responsible for everything and under no circumstances can Tenant cancel the lease.
Gross Lease: Tenant pays only Base rent. Landlord is responsible for ALL expenses.
Modified Gross Lease: Same as Gross Lease except expenses designated in the Lease. In addition, some Gross Leases have expense stops. In these cases tenants pay all expenses above a preset number.
CPI Increases: Some leases contain rental increases during the term of the lease. These increases can be either fixed specified amounts or they can be variable (CPI) based on cost of living indexes specified in the lease. These usually have annual and Total limits.
N.O.I.: Net Operating Income = income after an operating expenses and any reserves.
Cap Rate: N.O.I. divided by the Purchase Price Indicates yield on a non-leveraged purchase.
COC (Cash-on Cash): N.O.I. minus Debt Service decided by the down payment. Indicates yield on cash invested. (COC = Cap rate on non-leveraged purchase)
In cases where National 1031 Exchange Consultants is the seller's exclusive broker, we will share fees 50%-50% with the buyer's broker. In cases where National 1031 Exchange Consultants is not the seller's exclusive broker, our finder's fee will vary depending upon he property and parties involved. Typically, commission rates for single tenant properties tend to be lower than on similarly priced multi tenant properties.
Yes, if the property is exclusively listed by us or a source broker. However, most of the information on properties that are not listed is limited to executive summaries of one or more pages. In order to receive more information, particularly a copy of the lease, a seller will typically require a mutually signed letter of intent before providing this.
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