Some active developers in real estate thrive on doing 1031 exchanges as an alternative for traditional real estate transactions that involve the typical grind of budgeting hard and soft costs, exposing themselves to higher levels of risk, and leveraging debt on what is often a new (ground-up or major repositioning) or speculative project. However, certain tax benefits flow from doing a 1031 deal, most notably avoiding the capital gains taxes levied on those who make considerable income off of appreciation of their assets.
Furthermore, some developers prefer 1031 deals because they can use their money elsewhere to keep momentum going on other cash flow opportunities. This means that 1031 is attractive as a way to acquire property instead of leveraging debt with banks or creditors. In 1031 exchanges, similar uses of buildings must be there. But the similar uses for an interested developer could almost be interpreted as an added buffer, or margin of safety, to show that the asset is performing in that particular market. This is because the market has already naturally indicated that the existing (or similar) uses of the building are indeed valuable to community and to society. And anything valuable to society is usually followed by smart investors.
If you have questions or concerns regarding your taxation issues, you should consult the advice of a qualified attorney and include your accountant; however, there are some basic facts in the domain of public information for investors to get broad overviews.
What is a 1031?
The Internal Revenue Code, in Section 1031, provides that exchanges may be available for “like kind,” properties. Some parties have battled in court over the extent that one may interpret the true meaning of “like kind.” ( See IRC §1031(3)(A)) providing “any property received by the taxpayer shall be treated as property which is not like-kind property if
(A) such property is not identified as property to be received in the exchange on or before the day which is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange, or
(B) such property is received after the earlier of—
(i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or
(ii) the due date (determined with regard to extension) for the transferor’s return of the tax imposed by this chapter for the taxable year in which the transfer of the relinquished property occurs.
In addition to the timeliness requirements, 1031 exchanges are technical but once the learning curve is tackled many developers do them in volume, because they offer benefits to avoid capital gains taxes. In addition to the perfectly legal approach to avoid certain taxes, if investors are actively doing various real estate deals, then such flexibility offered with doing real estate swaps may keep life interesting while different and very timely/quick projects are underway. Senior housing is also very much a use considered in the 1031 exchange swapping markets.
Mitigating Risk With 1031
1031s, in other words, can be a way to get into the deal and get out of the deal with very little exposure. While the prudent investor should seek the advice of a lawyer for legal advice, some parties elect to evaluate their portfolios to explore potential opportunities that do not require legal expertise. Parties should be concerned about potential tax liabilities in their own investments. Every tax and investment situation is different. Talk to Cambridge Realty Capital today to discuss your particular investment circumstances.
