Holding on to Wealth with 1031 Exchanges

A 1031 exchange, named for its section of the Internal Reve nue Code, is a common method to postpone capital gains tax  when you are reinvesting the proceeds into another similar, or “like-kind”, property. Many people are surprised to find  how broadly the “like-kind” criterion is interpreted by the  IRS. Generally, any real estate in the U.S. held for business or investment purposes will be considered “like-kind” with  any other, regardless of type. There are no limits to the num ber of times you can do a 1031 exchange.

There are two important criteria that make this exchange different from a sale and a purchase.

1) The seller does not take  possession of cash from the sale. Most people use an intermediary to hold the cash between transactions.

2) All parts of  the exchange close within 180 days.

Example: You have been operating your business in a office building you bought for $300K and have an opportunity to sell it for $1M. Your capital gain would be $700K. (If you had been deducting depreciation expense  over the years, your cost basis would be lower and your gain higher.) If you sell the property for cash, you will  pay $105,000 in taxes (assuming a 15% tax on the $700K gain) and have $895,000 to reinvest. If you use a 1031  exchange, you can reinvest the full $1M into other real estate, even a warehouse, vacant land, or one or more  residential rental properties.  

The 1031 exchange is a valuable tool in preserving the wealth of your business and investment property. Like any  law, the tax code could change. There have been reports that one of President-elect Joe Biden’s policy proposals  would either curtail or eliminate some 1031 exchanges.