1031 Exchange For Commercial Real Estate Property

The 1031 exchange permits commercial property owners to defer federal and state capital gains and recaptured depreciation resulting from the sale of their holdings, provided real property of equal or higher value is bought within 180 calendar days of the closing. The commercial real estate 1031 exchange enables real estate owners to diversify their assets and reinvest in residential properties, oil and gas royalties, Delaware Statutory Trusts, and triple net leases if they choose to do so.

Typically, commercial properties consist of an improved structure that must be depreciated and usually include land. Both may increase in value to the extent that their sale will generate a profit. The taxes on the recaptured depreciation and gains can be delayed in a commercial real estate exchange transaction.

Like any commercial property exchange, the nature and character of the conveyed rights of the 1031 exchange properties must be considered to determine if they are substantially similar. This comprises the similarity of physical properties, the nature of the transferred title, the rights of the parties, and the duration or term of interests.

Types Of Commercial Properties Eligible For A 1031 Exchange

Commercial properties eligible for a 1031 exchange include, but are not limited to, the following:

  • Hotels/Motels
  • Storage Facilities
  • Office properties
  • Retail properties
  • Warehouse properties
  • Industrial properties
  • NNN properties
  • Medical office/Retail
  • Delaware Statutory Trusts (DSTs)
  • Multi-family properties, including high-rise or apartment complexes
  • Land used for speculation/Development
  • Special purpose (churches, government buildings, etc.)

Can Commercial Properties Be Used After A 1031 Exchange?

Yes, business owners may utilize the property they acquire in exchange for their business. For instance, a retail strip mall may be exchanged for an office building. In this instance, you are permitted to use the office building for your business. 1031 exchanges might facilitate the expansion of office or warehouse space required for commercial operations.

How To Know If A 1031 Commercial Properties Exchange Is Beneficial For You?

The benefits of a commercial real estate 1031 exchange include:

  • Since you defer taxes, you have greater purchasing power and more funds to invest
  • Greater marketability since there is no need to raise the price when selling the property to cover the taxes
  • Increased income potential when you exchange undeveloped property for a retail shop
  • Consolidate smaller income-producing properties into one larger or greater one
  • Can exchange individual office condominiums for a high-rise apartment building 
  • Can exchange commercial property in New York for investment property in Florida and relocate
  • Acquire a property that requires less management, exchange your rental home for undeveloped land
  • Expand a business to a larger size by exchanging a single-story office property for a multi-story office building

Does the New Tax Law Allow A 1031 Exchange With Commercial Properties?

Yes. The Tax Cut and Jobs Act became effective on January 1, 2018, after being signed into law on December 22, 2017. It is now known as the "Exchange of Real Property Held for Productive Use or Investment."

Different Types Of 1031 Exchanges

There are several types of 1031 exchanges. Any of the different exchange types may be utilized for commercial real estate property. 

  • Traditional Exchanges
  • Replacement Reverse
  • Forward Reverse Exchange
  • Improvement Exchange
  • Reverse Improvement Exchange

How To Complete A 1031 Exchange: Commercial Real Estate Version

The property acquired in a like-kind exchange must be of equal or greater value unless the excess funds are used for renovations.

A 1031 exchange normally requires eight stages to complete. Typically, a professional will handle these for you, as they can be complicated. The eight steps include:

  1. Sell the property investment.
  2. Transfer the capital gains to a qualified intermediary, such as a company or exchange firm.
  3. Determine a comparable property within 45 days.
  4. Send a duty letter to your authorized intermediary.
  5. Communicate with the seller of the comparable property.
  6. Establish a sales price.
  7. Have the intermediary send the capital gains to the titleholder or title company by wire transfer.
  8. Complete IRS Form 8824.

A 1031 exchange commercial real estate will enable you to defer depreciation recapture, which is the method for collecting income tax on the amount of depreciation claimed on a property, in addition to avoiding the hefty taxation on capital gains. This might save you up to 25 percent on your property's depreciation.

Moreover, a like-kind exchange could help you avoid state taxes. When a property is sold, several states compel either the buyer or the seller to pay state income taxes, known as state mandated withholding. The property exchanged in a 1031 exchange is exempt from taxation.

Remember that these are deferred taxes since you will be required to pay them if you sell the property for cash in the future.

Commercial Real Estate: 1031 Exchange

The 1031 exchange commercial property offers numerous benefits for commercial properties. These benefits include delaying capital gains taxes and growing your business. Take note that all commercial property types qualify for a 1031 exchange.
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