Motivation to sell commercial real estate can vary from desperation to windfall. Some sellers don’t have a choice — they must sell. Others will take advantage of a large run-up in pricing to reap some profit.
In the former, catalysts often include a loan that must be repaid, a business failure, or a pending foreclose. The latter often means taking advantage of market swings, an offer “too good to reject,” or an uptick in business.
Ideally, sale proceeds are rolled into another buy, which defers capital gains taxes. Such a mechanism is referred to as a tax-deferred exchange under Chapter 1031 of the Internal Revenue tax code.
Allow me to spend a moment and discuss some nuances of the 1031 exchange.
How an exchange works
Simply: A 1031 exchange defers both state and federal capital gains taxes. Any income property generally qualifies, including an owner-occupied building if properly structured.
Relinquished or downleg is the term typically used for the sold property. Replacement or upleg describes the property that was purchased. You’ve got 45 days — from the close date of your relinquished property — to identify a replacement property.
You must complete the upleg purchase in 180 days or April 15, whichever is soonest, of the following year from the sale date. “Like kind” must be bought. A fancy way of saying – another income property.
Finally, if your relinquished price was $1 million, you must spend $1 million or more to qualify. Don’t forget any loans as those must be replaced also — either with new borrowing or additional cash.
Whew! Complex? Yes! Please don’t attempt this at home. Consult tax, legal and commercial real estate professionals.
Can I do it myself?
No. Before closing on your downleg deal, you’ll need to designate a qualified intermediary to affect the exchange for you. IPX1031 Exchange is a good one.
Can I change my mind?
Yes. If you decide to forego an exchange before the sale of your downleg, you receive the sale proceeds albeit now with potentially a large tax bill looming. If you designate a qualified intermediary, close, and then pivot. You once again receive the boot, but it’s most likely taxable.
May I take some of the sale proceeds?
Simple answer, yes. In reality, the answer is more complicated. This is where legal and tax counsel can help.
When must the upleg be completed?
Some sellers overlook this nuance and have their exchange disallowed. The rule is the earlier of 180 days from your sale’s close date or the filing date of your taxes the following year – presumably April 15th.
Let’s say you close your relinquished property on July 17; 180 days later your replacement must be completed. However, if your close date falls after Oct. 15 of this year and you file tax returns April 15 of next year, your 180-day requirement shrinks.
Can I buy more than one property?
Yes, you may. Within your 45-day identification period you’re allowed to designate as follows:
- Up to three with unlimited value – you can then buy one, two or three;
- An unlimited number at 200% of the relinquished value – you’re allowed to buy several;
- An unlimited number with an unlimited value – but you must buy 95% of the ones identified.
Multiple exchanges?
If you sold and did a tax-deferred exchange and subsequently sold again, you’re allowed to affect another exchange. Currently, there is no limit on the number of these you may complete. Just remember: at some future sale point the taxes will be due. So plan accordingly.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.
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1031 exchanges: I’ve sold my commercial real estate. Now what? - OCRegister
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