Since 1921 U.S. investors have been given the opportunity to defer capital gains tax from the sale of property by using the Tax deferred 1031 exchange. A Tax Deferred 1031 Exchange allows an owner of real property, the Exchanger, to defer the recognition of capital gains tax normally recognized on the sale of real property; if the exchanger buys a like kind property of equal or greater value and uses all of its cash equity in a subsequent purchase of a replacement property.
Like kind NNN 1031 property exchange does not mean triple net properties to be exchanged for other triple net properties or freestanding NNN single tenant retail property to be exchanged for another NNN single tenant retail property. There is no requirement that properties be similar in type or class. However, real property must be exchanged for real property. Like-kind property is defined as property held for productive use in a trade or business, or for investment purposes, that is exchanged for property also held for productive use in a trade or business, or for investment purposes. Example, a vacant land which is held for investment purposes can be exchanged for retail property held for business purposes.
A 1031 exchange should be done through a qualified intermediary. A Qualified Intermediary is an independent third party to the transaction whose function is to prepare the documents necessary to create the exchange, as well as to act as the independent escrow agent for the exchange funds.
Tax Savings from a 1031 Exchange
Example: If an investor is selling a triple net shopping center for $1,000,000, and has a net adjusted basis of $500,000, the investor will have a gain of $500,000 upon the sale of the property. Current federal capital gains tax is 15% on the amount the property has appreciated in value. The investor will also pay a tax known as depreciation recapture of 25% for the amount the property that has been depreciated during its ownership. In addition, there may be a state or local capital gains tax.
Many investors multiply the gain by 25% to get a rough estimate as to the amount of tax they might owe if they do not structure the transaction as an exchange. In this example, the gain would be approximately $500,000. Accordingly, if we multiply this amount by 25% the estimated capital gains tax if this sale were not structured as an exchange would be $125,000.
Three methods for NNN 1031 Exchange Property Investments:
- Identify three properties of unlimited value (Most Common Method)
- Identify an unlimited number of properties whose aggregate fair market values do not exceed 200% of the value of the properties sold in the exchange
- Identify more than three properties such that their aggregate fair market value is in excess of 200%, plus, the Exchanger must purchase at least 95% of the value of the properties identified.
NNN 1031 Exchange Basic Conditions:
- Exchanger has 45 days from the date of the sale of the first relinquished property to identify potential replacement property or properties, and a total of 180 days from the original sale date to purchase the replacement property or properties;
- Exchanger must acquire replacement property of equal or greater value, obtain equal or greater debt on the replacement property, reinvest all the net proceeds realized from the sale of the relinquished property, and acquire only like-kind property;
- Exchanger must own an investment property for at least one year before use in a 1031 Exchange;
- Exchanger must initiate the 1031 process before the closing of the property being reliquished, once this closing occurs, it’s too late to utilize a 1031 deferred exchange;
- Exchanger may use a vacation home or primary residence for a 1031 exchange as long as these properties are reported as a rental or for business use on tax returns for two consecutive years.
Benefits of 1031 Exchanges for NNN Property
- When selling real estate, if you sell and reinvest, you will pay income taxes on the realized gain. However, using 1031 exchange, you will defer the capital gains taxes;
- You may have management-intense rental properties and would prefer to transfer your equity to ease-of-ownership single tenant properties such as Walgreen Drug Stores, Wal-Mart, Post Offices, 7- Eleven, Office Depot, etc.;
- You may have been holding properties long after their appreciation has topped out. You can start rebuilding your equity by disposing of those investments and acquiring new ones;
- You may own non-income producing real estate investments, such as raw land. You could exchange this property for another property asset that has cash flow, but also income tax deductions such as depreciation, which you did not have with your raw land;
- No capital gains taxes, means an interest-free loan from the government!
- You may have owned a leveraged property long enough to have accumulated considerable equity. You now have an opportunity to exchange into a larger asset, and reposition your equity to your benefit of that of your heirs, without paying taxes
- With proper estate planning you can keep exchanging properties throughout your lifetime. Neither you nor your heirs will ever pay income taxes on the gains. By doing a tax-deferred exchange, you conserve your equity by not having to pay taxes on your profits.
Constraints of a 1031 Exchange for NNN Investment Property:
- Exchanger will have a slightly lower depreciation schedule when acquiring new properties. This is because the IRS will look at the new tax basis as being the same as the previous one, less the deferred gain;
- Exchanger losses on their income tax return cannot be deducted if real property is exchanged, not sold. If you want to take a loss, simply engage in a sale, not in a 1031 exchange.
We offer 1031 exchange services accross the nation:
Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, District of Columbia, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Puerto Rico, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Virgin Islands, Washington, West Virginia, Wisconsin, Wyoming