A 1031 exchange refers to the sale of an investment real estate property used to defer capital gains taxes. There are very specific rules about timing, property type, and this process outlined in Section 1031 of the Internal Revenue Code. Our brokers have assisted many clients with this process. Cushman & Wakefield | Commercial Kentucky Senior Associate, Austin English had this to say about 1031 exchanges “We have had the opportunity to assist in multiple 1031 exchanges resulting in putting to work over 100’s of millions of dollars for our clients. The core benefit of a 1031 exchange is deferring capital gains taxes when you sell an asset or a whole portfolio and roll the proceeds into a “like-kind” asset. By reinvesting into a ground lease, you preserve your hard-earned equity and keep your capital working for you instead paying the long-term capital gains taxes. Many clients who opt for a 1031 are at a stage in life where they want to reduce headaches and downsize their current balance sheet from a management side all while still earning an easy return on their investment.” This article will outline several points for anyone who may be considering a 1031 exchange.

The first consideration may be what properties would qualify as a 1031 exchange. The exchange must be for a “like-kind” property. This means if you sell real estate, you can buy real estate. No personal property will be eligible. For example, you could not buy equipment, artwork, or cryptocurrencies. The property or properties must be of equal or greater value to defer 100% of the capital gains tax. If the purchased property is of lesser value, the difference, also known as the “boot” will be taxed.

It is beneficial to appoint a Qualified Intermediary (QI) as the process begins. This independent third party holds the funds in escrow until they are disbursed for payment on the replacement property. An investor has 45 days from the date of the initial sale to identify in writing possible replacement properties. By the 180^th day after that sale, the replacement property must be acquired.

The timetable on how this happens can vary. The most common would be a delayed exchange (as described above). There could also be a simultaneous exchange when both sale and acquisition happen at the same time. A reverse exchange is if the replacement property is purchased first. In this case the QI holds the deed until the property to be replaced has been sold. There could also be an improvement exchange where renovations have to occur before the sale closes and they must take place within those 180 days mentioned previously.

As stated, the reason for this type of sale is to defer the capital gains tax. Other benefits include a “step-up” for heirs if the property is passed along to the next generation. Essentially the deferred gains from the previous 1031 are eliminated. This also gives investors the opportunity to try their hand at owning different types of properties from apartment complexes to retail centers.

Austin English added, “In electing a 1031 exchange, while there are other avenues, we have helped our clients predominantly focus on acquiring absolute net, ground leases in income tax free states. With a ground lease, the tenant is usually responsible for taxes, insurance, and maintenance (triple net). That makes the asset nearly management-free, which is attractive for investors looking for mailbox money. With the addition of the absolute net lease this normally means there is no landlord responsibilities once the lease is in place.

Additionally, because ground leases are tied to the underlying land, they tend to hold their value.  Land in strong locations only gets more scarce, and the reversionary interest (the fact that the landowner ultimately gets the improvements back at the end of the lease) providing a mechanism for long-term wealth-building.”

Are you interested in real estate investments? This is your cue to act on it! Cushman & Wakefield | Commercial Kentucky will find the right type of investment for you. Contact one of our brokers to lead you through the process today.