Busting the Top 1031 Exchange Myths: Heres What You Need to Know
Carl E. Sera, CMT
May 2, 2023
Common Misconceptions About DST 1031 Exchanges and the Truth Behind Them.
A 1031 "like-kind" exchange allows real estate investors to defer capital gains taxes on property sales by reinvesting the proceeds in a replacement property. While participating in a 1031 exchange is simple, some investors need clarification on this opportunity. Here are seven typical misconceptions about 1031 exchange rules.
1031 Myths, Debunked
Today we are addressing some common misconceptions associated with 1031 tax-deferred exchanges.
Myth: A 1031 exchange must be simultaneous
All exchanges were simultaneous when the tax law was initially established in 1921. The two-party simultaneous exchange was increased over time to allow more opportunities to complete a transaction. The most typical type of 1031 exchange is a forward exchange, in which the profits from the sale of one asset are used to purchase a like-kind asset within a 180-day timeline.
Other 1031 exchange deadlines exist, but the 180-day completion term permits non-simultaneous transfers. With a reverse exchange, purchasing replacement property up to 180 days before selling the relinquished property is possible.
Myth: 1031 exchanges are a tax loophole
Congress enacted 1031 like-kind transactions (IRC) as part of the Internal Tax Code. The Internal Revenue Service's set of specific rules and tax laws (IRS). Congress codified this legislation as Title 26 of the United States Code, also known as the Internal Tax Code. The code is arranged by topic and covers all essential provisions about income, gift, estate, sales, payroll, and excise taxes.
Internal Tax Code was created in 1921 with two key goals in mind:
- To avoid undue taxation on ongoing investments
- To stimulate active reinvestment
Like-kind exchanges continue to support selling and acquiring real estate and corporate assets, foster business expansion, and stimulate economic growth nearly a century later. They are a deliberate and essential part of US tax legislation and regulations, not a tax evasion technique. According to a recent update, approximately 88% of properties obtained through an exchange are eventually sold in a taxable event. While some choose to have their gains deferred, many choose to pay taxes.
Myth: “Like-kind” means that a property must be exchanged for the same type of property
The term "like-kind" in real estate is extensive. All real estate is regarded as "like-kind." Land can be converted into an office building, and rental property can be converted into a condominium. A multi-family complex can be converted into twenty rental homes via a Delaware Statutory Trust (DST). The list could go on, but the point is that there are many possibilities when performing an exchange in real estate.
Myth: All of the funds from the sale of the relinquished property must be reinvested
A taxpayer can buy down in value. In an exchange, a taxpayer may withhold cash or receive other non-like-kind property. However, the amount they buy down, the money they withhold, or any other non-like-kind property obtained is deemed "boot," which means the exchanger will almost certainly have to pay some taxes.
Myth: Exchanges are only applicable to the larger properties
Whether you have $20,000, $200,000, or $2,000,000 to defer, an exchange provides the same benefits. Rather than paying the tax liability now, you can roll all gain into a property and continue to enjoy appreciation. An exchange should be viewed as an IRS interest-free loan where the principal can be increased and, if correctly planned, never repaid!
Myth: If I sell property, I can only exchange it into one property
You can sell one property and exchange it for many replacement properties. You can also sell multiple properties and exchange them for a larger, easier-to-manage property. A good example is selling and trading numerous properties into a single DST property or a DST that a major multi-billion-dollar REIT can buy.
Myth: 1031 Exchanges Are Too Complicated
While there are numerous moving parts and strict standards to follow, participating in a 1031 exchange isn't too complicated. Partnering with an experienced, Qualified Intermediary and your tax, investment, and legal consultants can help make the process go as smoothly as possible.
Clearing up the misconceptions about what 1031 like-kind exchanges are and how they work continues to be part of Sera Capital’s mission since the first step to employing like-kind exchanges is understanding them.
If you want to understand more about 1031 exchanges and how they can help you, the team at Sera Capital is here to help. Please get in touch with us right away to schedule a consultation.
Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.”
If you want to explore your options, make a no-obligation appointment with us today. Discover the possibilities.