Investors often ask if we can do a 1031 exchange on a property to defer taxes on the gains upon sale. A syndication structure (apartment or self-storage) does make it more challenging to do a 1031 exchange but it can certainly be done. Here at BluPhoenixAdvisors.com, we plan to do a 1031 exchange upon the sale of each asset and bring investors along with us. And we do provide options to investors to liquidate their shares if they want to get out. Before we get into the mechanics of the 1031 exchange, let’s dive into what a 1031 exchange is and why it is important to consider using the 1031 exchange to build your wealth.

What is a 1031 exchange?

L'échange 1031 est une stratégie de report d'impôt très efficace qui a été lancée en 1921, soit trois ans à peine après la promulgation du premier code de l'impôt sur le revenu par le Congrès. Depuis lors, son histoire est compliquée et a connu plusieurs itérations. Lorsqu'elle a été promulguée pour la première fois, il y a près de 100 ans, elle autorisait les dispositions d'échange de biens non similaires, mais cette mesure a été rapidement éliminée en 1924.

The current 1031 tax code allows like-kind real estate asset exchange to defer capital gain taxes. This can only be performed with real estate capital gains (psst… there is even a strategy to be able to use this on your primary residence which we cover in this article).

Why is it important to know how to leverage a 1031 exchange?

One of the major benefits of doing the 1031 exchange is the ability to defer the tax on capital gains and to avoid depreciation recapture. However, if you sell and take the proceeds out instead of opting for the 1031 exchange you will pay the capital gains tax.

Si vous pouvez continuer à utiliser l’échange 1031 jusqu’à votre décès, votre « base » dans la propriété sera réinitialisée à la valeur actuelle de l’investissement à votre décès, car l’investissement sera transmis à vos héritiers. C’est ce qu’on appelle une « augmentation de la base ». C’est aussi la raison pour laquelle l’échange 1031 est souvent appelé un « jeu de patrimoine hérité », car cela vous permet de ne jamais payer de gains en capital (ou de récupération d’amortissement) et de laisser davantage à votre famille à votre décès.

Another reason to consider a 1031 exchange is to keep your capital working hard with minimal downtime. It can be very frustrating for an investment to liquidate, and then you are having to search for a replacement investment and earning no income.

All these reasons together, help you build passive cashflow now and generational wealth later and we love working with investors for the long haul in building wealth as opposed to one off investments.

How is the 1031 exchange executed?

(See Figure 1 for a visual of this process) When we have decided to sell a property, we will poll the limited partners in the entity that holds the asset to see if they want to participate in the 1031 exchange. We do this early in the sales process since the next property (called a replacement property) must be identified within 45 days of closing. Then we must close on the new property within 180 days from closing to qualify. To remain compliant with the tax code, we must use a qualified intermediary to handle all funds between the sale of the initial asset and the purchase of the replacement asset.

When we poll investors via email, we do our best to have an asset identified to exchange into, but it’s not always the case. As the limited partner investor, you will have two choices: participate in the 1031 exchange or to liquidate your proceeds.

If you choose to participate in the “exchange” your initial capital and capital gains from the sale must roll over in the exchange. Completing the survey by the requested deadline is the only action you need to take until documents are ready for signature. Depending on the next asset being purchased, if you participate in the 1031 exchange, it may also be possible to add to your initial investment.

If you do not participate in the 1031 exchange; you’ll provide disbursement instructions for how you’d like to receive your proceeds from the sale.

In either case, be sure to consult with your tax professional to understand your complete tax situation.

In Conclusion

Completing a 1031 exchange can be very tricky as there is a certain timeline and many moving parts that must be followed for it to work properly, according to the IRS guidelines. Hence, the reason why you will find that many operators choose not to do a 1031 exchange at all at the end of their deals since it takes more time, energy, and effort to complete the transaction.