1031 Exchange

David Mueller-Flores
FIN 120 MW 2PM
Dr. Hansz

1031 Exchange

I am sure that like many of my classmates the idea of real estate as an investment opportunity seems very enticing to me. As a kid I would love to play the board game Monopoly, I was absolutely thrilled every time my competitors would pay me rent. As an adult one of my jobs has been to maintain and rebuild our rental properties. Knowing that one day I would be given control of my family’s rental properties I decided to declare Real Estate as my option at Fresno State. When we started getting deeper into our material over the semester I had a few things really capture my interest. The one that I have decided to discuss for my final blog post is the 1031 exchange.

Naturally, I shall begin by explaining what a 1031 exchange is. The Internal Revenue Service (IRS) “US CODE: Title 26, §1031. Exchange of Property Held for Productive Use or Investment” is quite specific and detailed regarding what qualifies in order to defer the capital gains tax which would normally occur after a property is sold (US CODE: Title 26,1031. Exchange of Property Held for Productive Use or Investment, 2011). In short, real estate that is held for income or investment can be exchanged with the tax deferred for any other real estate that is to be held for income or investment. For instance if a apartment complex was sold and then soon later a different apartment complex was purchased the tax from capital gains would be deferred to the new property at time of sale (McKenzie, 2011).

It is highly recommend that before attempting to go through a 1031 exchange that you first discuss it with your attorney or tax advisor. There are several conditions and regulations regarding a 1031 exchange, which I shall briefly highlight a few. Essentially, as an exchange there is no recognition of a gain or loss and the taxes that would be paid on the gains are deferred. The key to a properly structured 1031 exchange is to make sure that you do not receive cash or a cash equivalent, also known as a “boot.” A “boot” is defined as any unlike property received in the exchange (McKenzie, 2011). You must also identify the property for exchange before closing, identify the replacement property within forty-five days of closing, acquire the replacement property within one hundred and eighty days of closing, and also use a qualified intermediary to facilitate the transaction. In order to complete a 1031 exchange each of these conditions must be met which is which is why it is highly recommended to consult with your attorney or tax advisor before going through with the sale or exchange (Hansz, 2010).

It is well worth the effort in order to receive the benefits of a 1031 exchange. Deferring your capital gains tax is not the only benefit. For instance, this is not just a one time deal and it is possible to make multiple exchanges. It is not uncommon for this process to be repeated where capital gains are repeatedly deferred and when the investor finally passes away his heirs will receive the property tax-free (McKenzie, 2011). This provides us with an opportunity to continue investing in real estate and know that our sons and daughters will be able to continue without having to pay the capital gains tax that we had deferred over our careers.

In conclusion, I’d like to suggest to all my classmates who are considering investing in real estate whether it be residential or commercial to discuss this opportunity with your attorneys or tax advisors. Everyone realizes how difficult the IRS makes it to optimize your refund on income tax and they made sure that it would be just as difficult to complete a 1031 exchange. The benefits that one receives from going through with the exchanges make it well worthwhile and worth consideration as we begin investing in the real estate market.

Bibliography

Hansz, J. A. (2010). Real Estate Analysis: Environments and Activities. Dubuque, IA: Kendall Hunt.

McKenzie, D. (2011). Essentials of Real Estate Economics 6e. Mason, OH: Cengage Learning.

US CODE: Title 26,1031. Exchange of Property Held for Productive Use or Investment. (2011). Retrieved from 1031exchangemadesimple.com: http://www.1031exchangemadesimple.com/uscode-1031.html