The 1031 Exchange: What Is It?
If you are planning to invest in commercial real estate, you'll need to know about the 1031 exchange. This is a way to avoid paying the taxes that would typically need to be paid if you personally received all of the proceeds from the sale of a building when purchasing a new one. Here is what you need to know about this important legal tool.
You Can't Hold Sales Proceeds
The purpose of the 1031 exchanges is all due to needing to get around the problem of what happens when you sell a property. While you would think that it would be no big deal to receive the proceeds from a sale in your own bank account, this will actually trigger having to pay capital gains taxes on that sale. What actually happens is that the sale proceeds go through a qualified intermediary, who is a third party that is involved in the sale as part of the 1031 exchange.
You Must Decide on Using a 1031 Exchange Early On
Since you are going to be involving third parties in the sale of your commercial property, it is not exactly something you can just add to the process at the end. You'll need to plan for this exchange in advance. It is not something that can be done after the fact when you figure out that you have to pay capital gains taxes on the sale.
You Must Find a New Property to Buy
If you are going to be selling the commercial property and getting out of the investment game, then there is no way to avoid paying those capital gains taxes. However, if you plan on buying a new property, you need to line up that purchase at the same time to handle the 1031 exchange. It doesn't have to be similarly priced or a similar type of property, but it must be equal to or greater in price than the property you are selling.
Since timing is so crucial for the 1031 exchange, you'll want to line up several potential properties in case one falls through. If not, you could end up being stuck making the sale and paying capital gains taxes. It is also possible to identify multiple properties so that it is not a straight-up, one-to-one transaction so that the sale proceeds can be used to fund multiple properties and still avoid paying capital gains taxes.
