There are so many elements of commercial real estate, it can make your head spin. (That’s actually part of the reason we designed our tool—to make CRE tasks more manageable.) One of those elements that some CRE professionals may not be familiar with is the 1031 exchange.
A reference to IRS Section 1031, these exchanges are an important tax guideline for commercial real estate professionals, as they allow you to avoid many capital gains taxes. But there are rules to follow. Let’s cover what 1031 exchanges are, how they work and more.
What Are 1031 Exchanges?
First off, 1031 exchanges can apply to any form of real estate investing, whether residential/traditional or commercial. According to Investopedia, “a 1031 exchange (also called a like-kind exchange or a Starker exchange) is a swap of one investment property for another. Most swaps are taxable as sales, although if yours meets the requirements of 1031, you’ll either have no tax or limited tax due at the time of the exchange.”
How Do 1031 Exchanges Work?
In commercial real estate, a 1031 exchange lets you delay your capital gains taxes in a way by selling the property with the gains and using profits toward a similar property. If there are no proceeds/profits, you don’t have to worry about taxable income.
To illustrate further, here’s an example of the basic process for 1031 exchanges:
- Choose the properties to “swap” (one you’re buying and one you’re selling)
- Partner with a qualified intermediary (to facilitate the exchange)
- Inform the IRS of the exchange (using IRS Form 8824)
You may see some other verbiage you don’t recognize, such as “relinquished property” (a reference to the property being sold) and “replacement property” (the property being bought).
When To Use 1031 Exchanges
Now the big question: when do these exchanges make financial sense for you and your portfolio? There are several reasons to pull the trigger, but the biggest is managing high profits in a way where you’re not stuck with an unexpectedly high tax bill. Here are a few other examples of when using 1031 exchanges is worth considering:
- There is a similarly-priced property with better return potential than a property you own.
- You want to split up your property investment into multiple properties.
- Or, you might do the reverse and combine investments into a single property.
- You want to do a reset on depreciation for your property.
If you’d like to see how Quarem can help you with 1031 exchanges and other elements of commercial real estate, request a demo today.