A 1031 Exchange allows a tax-paying investor to defer capital gains taxes on an NNN investment property when sold, as long as another “like-kind” replacement property is purchased by the sale proceeds of the property being relinquished.
However, because of the enormous complexity of using the 1031 Exchange process, it behooves investors to know when to engage in a 1031 Exchange, and when not.
When to Engage in a 1031 Exchange
· Leverage tax law changes: Recent changes in tax law have eliminated most all 1031 exchange asset types, except for real property. This means: real estate NNN investors win.
· Grow capital, infinitely: So far, there is no cap on the # of times a taxpayer can do a 1031 exchange. That means an investor can turn a single NNN investment into two or more, and keep exchanging to grow a massive real estate portfolio.
· Diversify portfolio risk: Like-kind exchanges aren’t constrained within state lines. So, additionally investing into an up-and-coming triple net property market early, in different states, could lead to bigger returns, later.
· Achieve greater exit flexibility: purchasing a portfolio of properties gives an investor the freedom to sell portions of assets over time, on their own schedule.
· Trade up for higher-value properties: a 1031 exchange lets an investor trade up to a property or portfolio with higher returns or qualities. For example, one NNN investor was able to triple property cash flow by doing a 1031 exchange from a single NNN lease property into a large portfolio of townhome rentals in Detroit.
· Reset Depreciable basis for bigger tax savings: investors in NNN lease property can utilize “depreciation” of a real estate asset, as a tax shelter. For example, the IRS recognizes 27.5 years as the depreciable time period for an investment property, giving the potential to shelter investor income because of a tax deduction for depreciation. However, property appreciation is typically realized by the value of the land and not the property – which also gets improved, over time. During a 1031 deferred exchange, an investor can elect to reset the depreciation on NNN property holdings to a higher basis, thus leading to a bigger tax benefit.
When Not to Engage in a 1031 Exchange
· Don’t have the “team” in place: without your “dream team” of an experienced and resourceful commercial property NNN broker, a CPA with years of real estate tax experience, or a savvy and highly niched attorney who specializes in 1031 exchanges, or a Qualified Intermediary, who has conducted at least a few hundred 1031 exchange transactions, don’t attempt a 1031.
· The property will never be sold: a 1031 Exchange allows a triple net property investor to delay paying taxes but doesn’t eliminate capital gains tax. Only if a 1031 exchange relinquished property is never sold or a 1031 exchange is conducted ad infinitum(NNN broker, triple net property investor ), will a tax liability not arise. But keep in mind: the median holding period for a commercial property in America is between 7 – 8 years.
· Cannot meet timelines: there are very strict timelines embedded in 1031 exchanges. Investors have 45 days to identify NNN property to buy and close on such property(s) within 180 days. So if an investor is not prepared to make things happen quickly, it is wise not to proceed.
· Cannot find suitable replacement property: it can be very challenging to find “like-kind” replacement properties, especially within the time constraints of 1031 exchanges(1031 Exchange process, single NNN lease property, NNN broker). NNN lease property investors shouldn’t have to scramble and end up with sub-par replacement property just to avoid capital gains taxes (which are a certainty at some point).
Begin with calling the Triple Net Investment Group if you are considering a 1031 Exchange. Our advisors can offer deep resources and expertise, together with introductions to CPAs, Attorneys and QIs, who can best assist you.
