By Jill Jones | Wealth Management
Section 1031 has helped property owners build wealth through like-kind exchanges since 1921. While some rules have evolved over the years, 1031 is still a valuable strategy for real estate investors. If it’s been a while since your last exchange, you might not realize some of the ways 1031 can enhance your real estate strategies. Here are a few 1031 highlights that financial advisors should share with their clients.
The Flexibility of “Like-Kind”
IRC Section 1031 allows property owners to defer capital gains taxes and depreciation recapture on the sale of real property held for business or investment purposes if they acquire a “like-kind” property within a set time frame.
Before 2018, qualifying exchange property included just about anything owned for business or investment purposes, from artwork to aircraft and all kinds of real estate in between, but now 1031 only applies to “real property.” For real estate investors, the good news is that the definition of “like kind” is still fairly broad. This means you can exchange between many different kinds of real estate, so long as both the property to be sold and the replacement property are used in a trade or business or held for investment.
Trista Snyder, business and corporate transactions attorney at Rose Law Group:
The interesting thing to remember is that any property held for productive use in a trade or business or for investment can be exchanged for like-kind property in a 1031 exchange. “Like-kind” refers to the nature of the investment. Any type of real property (except personal property, which is subject to a Section 121 capital gains exclusion) can be exchanged for another type of real property, which defers capital gain exposure. Closure of capital gains loopholes are regularly a topic of congressional debate, but actions rarely get passed.
Exchangers with investment capital, but not a lot of time for diligence or direct management of the asset might consider a Delaware Statutory Trust (DST). With respect to a DST, there are several things to remember: (1) investors must be “accredited” and will purchase fractional shares of the DST as a beneficiary, in a passive capacity, (2) investors trying to complete 1031 exchanges and defer capital gains taxes have just 45 days from the close of sale of their relinquished assets to formally identify suitable like-kind properties – DST offerings can reduce transactional risk because they are pre-packaged by sponsors – due diligence, inspections, environmental reports, financial statements, rent rolls and financing are already in place, so exchange investors can quickly meet the deadlines and conduct due diligence before the 180 days required under the 1031 exchange law, and (3) not all DSTs are created equal, so an exchange investor should investigate and consider using an expert attorney or advisor to make sure the DST fits the investor’s risk and tax profile.