The country’s hot real estate market is leaving more and more people with significant potential taxable gains if they were to sell. Farmers, business owners, and real estate investors can benefit from the tax-deferred exchanges from section 1031 of the tax code when they make the decision to sell and buy “like-kind” property. Of course, there can be hesitations to sell the property at a significant gain due to the tax implications some believe they will incur. But, when that gain goes towards the continuity of investment, specifically a business investment, section 1031 can defer it.
1031 Exchanges FAQs
In A frequently asked question about 1031, or like-kind exchanges (LKEs), is what does tax-deferred mean? When utilizing a like-kind exchange, you are selling and buying real estate to support your business or investment portfolio. By using the required third-party Qualified A person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person. Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written "exchange" agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer. Intermediary (QI), the taxpayer will defer the gain on sale and be able to reinvest the proceeds in another property to grow their business or portfolio. The taxes are paid only when the taxpayer receives the gains from the sale of a property. By deferring the taxes owed to the government, more cash is available to reinvest in a new property.
Environmental Benefits of 1031 Exchanges
Everyday more and more investors and companies are leveraging the benefits of the 1031 exchange to go "green" by investing in more energy-efficient buildings and properties that support renewable energy such as solar arrays and wind farms. Beyond the purely environmental benefits, companies and investors realize the added investment value and cost savings of these green investments. This includes lower ongoing energy costs, higher resale values, stable income production, and upfront and ongoing tax incentives.
There are various ways in which investment and environmental benefits can align:
- An investor owns a business in Arizona, where they do not have the capital or desire to retrofit the business to be more-energy efficient. and have a significant gain if they sold and then moved to a new location. Using a like-kind exchange, the building owner can exchange their inefficient energy property for a more environmentally friendly building, which allows them to defer taxes on capital gains from their original property.
- An investor cannot find an energy-efficient new building to purchase. Many real estate investors and companies are unaware that they can leverage a 1031 exchange to buy and make substantial improvements to that property over 180 days. In this case, the investor can leverage an improvement exchange to sell their current property and use the proceeds to purchase and then improve the new property to become more energy efficient.
- An investor wishes to exchange into or out of a renewable energy source such as a wind farm in Massachusetts. The value of wind farms is primarily a function of the value of the lease, i.e., the rent or royalties, term, and strength of the lessee. Often, the sale prices can be considerable, which may cause a significant tax event to the seller. In many instances, the availability of a 1031 exchange can be the key to enabling a sale to take place by minimizing the tax burden to the seller.
So go ahead - go green and save some green at the same time.