Why 1031 Exchanges Should be Preserved

As part of a multi-part infrastructure spending plan, President Biden has proposed capping Section 1031 like-kind exchanges by disallowing taxpayers from utilizing 1031 exchanges if their gains exceed $500,000.

Repealing the 1031 exchange provision would harm real estate investors of all sizes by forcing them to forego new investments or go into debt to finance their transactions. On top of that, it would also fail to raise significant revenue.

What are 1031 Exchanges?

1031 exchanges allow taxpayers to defer taxes on their capital gains if they reinvest those earnings in a new replacement property. Section 1031 has existed in the tax code for 100 years. Because investors don’t have to pay tax until they cash out, Section 1031 eliminates a potential barrier to investment, which promotes a more efficient allocation of capital resources.

1031 Exchanges are NOT a Tax Loophole

Critics of 1031 exchanges falsely claim that they are a loophole that allows taxpayers to avoid paying taxes. This is not true. The 1031 exchange provision defers rather than eliminates tax liability. A taxpayer that utilizes Section 1031 will eventually have to pay taxes on the asset when they cash out.

This tax deferral period is often shorter than many assume because taxpayers do not utilize 1031 exchanges indefinitely.

How do 1031 Exchanges Benefit the Economy?

There are significant benefits to the tax deferral offered by 1031 exchanges. Recent studies have found that 1031 exchanges provide taxpayers with liquidity that they can use to invest and create jobs. By providing additional liquidity, 1031 exchanges allow investors to avoid taking on debt and becoming over-leveraged. This also helps with the financing of new real estate projects, promoting a competitive and affordable housing market.

1031 exchanges are typically used for smaller real estate transactions. According to the National Association of Realtors, 1031 exchanges were used in roughly 12% of real estate sales. Almost 85% of these transactions were from smaller investors such as sole proprietorships or S corporations.

Repealing 1031 exchanges would increase holding periods as taxpayers would be encouraged to retain assets longer to avoid paying capital gains taxes.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

What to Remember When Reinvesting 1031 Exchange Proceeds

If you are in the process of selling four real estate investment properties, would a 1031 exchange work if you reinvested a portion in storage units as a business? The short answer is, yes - real property ownership of US storage units can qualify for 1031 exchanges, if they are held for investment / business purposes.

Real Property Exchanges

All U.S. real properties (brick/mortar and land) are generally like-kind, regardless of whether the properties are improved or unimproved. However, real property in the United States and real property located outside of the United States are not like-kind.

3 Rules of Thumb

There are three general rules of thumb to quickly see if you will defer ALL of the recognition of gain.

1. Typically you will acquire replacement property that is “up or equal” in Value* (price); {*net of sales commissions and customary transactional expenses}

2. You will roll over all of your Equity (net proceeds) from the relinquished property into your replacement property.

3. And to the extent that you were relieved of liabilities and Debt, such as mortgages on your old relinquished property, the debt relief is offset by (1) new liabilities or mortgages taken on in conjunction with your purchase of the replacement property; OR (2) by investing additional cash in the replacement property equal to the amount of liabilities and debts that were discharged.

You can have a partial tax deferral if you miss these general benchmarks.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

How Much Time Does a Title Company Need to Complete a 1031 Exchange?

There are numerous parties involved in any given 1031 exchange – from the taxpayer conducting the exchange to the qualified intermediary, to the title company. In this article, we are going to talk about how much lead time you need to give your title company going into the transaction.

Give Your Title Company Time

In a 1031 exchange, where you only have 180 days to complete your transaction, it’s always a good idea to get ahead of the ball. That goes for your title company as well. You do not want to first contact your title company the day before your closing. Waiting until the last minute to change up your transaction is going to create a lot of headaches for everyone involved – including your title company. If you wait too long, there may not be enough time to prepare the necessary documentation for a 1031 exchange.

Reach out to your qualified intermediary well in advance of your relinquished property closing date. This will give them enough time to prepare all of your required documents, and work with the title company to ensure a smooth transaction. A crazy closing process is nobody’s idea of a good time. Give yourself and your title company plenty of lead time (as much as possible) when doing a 1031 exchange.

Exchange Like-Kind Real Estate

Deferring capital gains taxes on the sale of real estate is easy under section 1031 of the Internal Revenue Code. It’s even easier with the help of a skilled 1031 exchange intermediary. At CPEC1031, LLC, our intermediaries have been facilitating exchanges for taxpayers across the United States for more than two decades. Give us a call today to get started with your 1031 exchange (the earlier you start – the better!). Our primary office is located in downtown Minneapolis, but we work with clients all over the state and country.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Capping 1031 Exchanges will Result in Economic Stagnation, Not Recovery

The 1031 exchange is an essential tool needed to rebuild the American economy after the damages done by the COVID-19 pandemic – and it is at serious risk as part of the American Families Plan being considered in Washington.

Every community in the nation, including those here in the Twin Cities, have witnessed the closing of countless malls, shopping centers, hotels, office buildings, and restaurants due to the fallout from the pandemic. In order to regain economic strength, we will need to substantially reinvest in and repurpose these properties. 1031 exchanges are a perfect tool for accomplishing just that!

1031 Exchange History

For the past 100 years, 1031 exchanges have been a cornerstone of the U.S. commercial real estate market. Like-kind exchanges generate economic benefits which far exceed the amount of taxes deferred. The American Families Plan proposes to cap the amount of gains that can be deferred via 1031 exchange at $500,000. This is a counterproductive cap that would result in economic stagnation, not recovery.

Contrary to a common misconception, a 1031 exchange is a deferral, not an elimination of tax. According to a study done by professors David C. Ling (Univ. of Fla.) and Milena Petrova (Syracuse Univ.), 80% of the taxpayers who conduct a 1031 exchange do only one exchange and then dispose of the property in a taxable sale. A restrictive cap on commercial real estate reinvestment would send an already struggling market into a tailspin.

1031 Exchanges Create Jobs

1031 exchanges are also a powerful job creation tool. Ernst & Young estimated that the reinvestment through 1031 exchanges for the coming year will create more than 560,000 new jobs paying more than $27.5 billion in labor income, generate $14 billion in federal, state and local taxes and add $55 billion to the GDP.

For many in the middle class, including many Black, Latino, and Asian realtors and investors, 1031 exchanges serve as their retirement strategy. Many of these groups are, for the first time, beginning to realize the hope of creating intergenerational wealth and a comfortable retirement by investing in real estate. They should not have to face the threat of a cap on using 1031 exchanges to attain these goals. 

What are Qualified vs. Non-Qualified 1031 Exchange Expenses

In a 1031 exchange, you have to be very careful in handling your expenses. What are qualified exchange expenses that you may use on your 1031 closing expense sheet, and what are non-qualified expenses?

A General Rule

The general rule is you’re supposed to move all of your equity from the sale of the relinquished property into the new replacement property. However, the exception to the rule is that you can pay certain qualifying expenses. The classic example is the real estate agent's commission on the relinquished property. You can also pay the title company, the county recorder, and other customary expenses that would be seen in that locality.

Non-Qualified Expenses

You probably can't put your Home Depot credit card bill or your Netflix charges on the settlement statement because you don't customarily see those expenses on closing statement and they're probably not related to the sale of the relinquished property.

Debt

Sometimes people want to pay off debt that may or may not be secured by the property. While that is not really an expense related to the sale, it is a cloud on title that oftentimes has to be removed in order to convey marketable title to the buyer. If the debt is secured by a mortgage or other lien it's clear that it has to be paid and is appropriate to be paid on the settlement statement.

Where it gets a little dicey are notes and other loans that may not necessarily be secured by the property, or encumber the property but for which there is a contractual requirement that the debt has to be paid if the property is ever sold. In those situations, the IRS will permit you to use exchange funds to pay off that debt that you are contractually required to pay, and you may be able to offset that debt relief with new debt on the replacement property so that the old debt does not trigger boot or mortgage boot on the sale of your old relinquished property.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved