For almost any significant business-related decision, management has to evaluate risk and costs against opportunity. In terms of real estate companies, this means a careful evaluation of when to hold, sell or buy, commercial, industrial, or residential real property. While the success formula is different for every business, items such as location, demand, condition of the property, and financing options are part of the calculation. When negotiating terms, many focus on the financial details of the transaction, placing less emphasis on tax implications. While there is undoubtedly a bevy of considerations, it’s essential not to forget about taxes. Proper tax planning can reduce overall taxes leaving the owner with a more significant share of profits. For sellers, it allows them to address capital gains tax carefully.
What is a 1031 Exchange?
A 1031 Exchange is a tax deferral method that allows a commercial property company or individual owner to “exchange” one business or investment real property for another without recognizing the gain from the transaction. It permits the owner to reduce their tax burden while increasing return on investment (ROI).
Changes Arising from Tax Reform
The Tax Cuts and Jobs Act of 2017 (tax reform) made significant changes to the tax code, modifying or eliminating many tax incentives, deductions, and planning opportunities. While tax reform did change some 1031 rules, it did not eradicate the benefit. The tax benefit of a 1031 exchange can only be applied to real property that is held for use in trade, business, or for investment. Any property that is maintained primarily for sale does not qualify for an exchange.
Those with industry experience understand that buying or selling real estate is a complex process with many variables to consider. However, the formula becomes far more complicated when leveraging an exchange. Various rules must be followed, including a timeframe for finding a new property, closing, and the need of an intermediary to hold proceeds from a sale. There are also rules on property holding times that must be considered.
The use of a 1031 exchange is a powerful tax-saving tool that commercial real estate companies should consider before completing a transaction. The opportunity is compelling and offers many benefits. If you need assistance with real estate-related tax planning or with a 1031 exchange, Klatzkin can help. For additional information, call us at 609-890-9189 or click here to contact us.