BY MICHAEL STOLER
In a simple explanation; a 1031 exchange, also called a like kind exchange, is a swap of one business or investment asset for another. If one comes within a 1031, you will either have no tax or limited tax due at the time of the exchange.
In effect, the investor or owner of a real property can change the form of investment without cashing out or recognizing a capital gain. That allows your investment to continue to grow tax deferred. You can roll over the gain from one piece of investment real estate to another. While you may have a profit on each swap, you avoid tax until you actually sell for cash many years later. Then you pay the tax on the gain at a long term capital gain rate.
Section 1031 tax deferred exchanges have been part of the tax code since 1921. Section 1031 allows an investor who holds the property for investment purposes, or for use in a trade or business, to defer all four levels of potential capital gains by exchanging for qualifying like kind property under, section 1031. By deferring the capital gain, an investor has significantly more purchasing power and better overall investment returns.
Most 1031 exchanges are of real estate. However, some exchanges of personal property, such as a piece of art work, can qualify.
Without getting technical most exchange must merely be of “like kind.” You can exchange a multifamily apartment building for raw land, a retail shopping center or other real estate assets.
In general, once the sale of your property occurs, you transfer the intermediary (qualified 1031 Exchange Company). Within 45 days of the sale of your property, you must designate replacement property to the intermediary, specifying the property you want to acquire. You must then close on the purchase of the new property within 180 days of the sale of the old. The two time periods run concurrently, which means you start counting when the sale of your property closes. If you designate property exactly 45 days later, you’ll have 135 days left to close on the replacement property.
One of New York City’s leading investment sales brokers told me that currently more than 25 percent of the transactions are as a result of tax deferral for 1031 exchanges. Investors of all levels, which include an owner of a retail or multi-family property as well as Blackstone Group on the sale of the Waldorf Astoria, are taking advantage of the section 1031.
Congress is trying to lay the groundwork for long term comprehensive tax reform and many are suggesting eliminating 1031 exchanges as part of its tax proposals. Proponents of 1031 exchanges feel that like kind exchanges benefit millions of American investors and businesses every year. Section 1031 exchanges encourage businesses to expand – including the development of real estate – and keep dollars moving in the U.S. economy.
Michael Stoler is the managing director for Madison Realty Capital and president of New York Real Estate TV LLC. He is also the host of the Stoler Report – New York’s Business Report, which airs eight times per week on CUNY TV.