Commercial Real Estate
Commercial Real Estate (CRE) includes real estate used exclusively for business and generating income, including office buildings, retail centers, industrial warehouses, multi-family housing complexes, hotels, and more.
1031 exchanges are popular for commercial real estate because they allow investors to defer capital gains and other associated taxes, preserve equity, and strategically reposition their real estate holdings without a significant tax burden, making them a powerful tool for long-term wealth building and investment growth.
CRE Data Insights
To better understand the current landscape and investment opportunities in CRE, it’s essential to look at key data metrics that highlight trends and performance within the commercial real estate sector.
Buying Prior to Selling
In many commercial real estate scenarios, timing is everything. reverse exchanges, where the replacement property is acquired by an Exchange Accommodation Titleholder (EAT) before the relinquished property is sold, offer critical flexibility for business continuity and investment strategy.
Reverse exchanges can provide the following benefits:
- Business Continuity: Move seamlessly without losing customers, revenue, or operational momentum.
- Tenant Retention: Transition to a new investment property while keeping the current one cash-flowing until the sale is finalized.
- Custom Build-Outs: Renovate or build out the new space before vacating the old one.
- Strategic Planning: More control over the timeline, reducing the risk of rushed decisions or missing IRS 1031 deadlines.
Construction & Improvements
In commercial real estate transactions, it’s common for an investor to sell a relinquished property at a higher value than the cost of the replacement property. Without further action, the excess funds—known as “boot”—would be subject to capital gains tax. However, a strategic alternative is to apply those surplus proceeds toward constructing ground up developments or making capital improvements to the replacement property.
These approaches are known as:
- Improvement Exchange
- Build-to-Suit Exchange
Through these specific exchanges, investors are able to reinvest the full value of the exchange and potentially defer all taxable gains—while also customizing the property to better fit their operational or investment goals.
Financing Improvement Exchanges
Financing typically plays a critical role in the completion of a successful Improvement Exchange to appropriately account for any debt payoff on the sale of the relinquished property. Securing appropriate financing is not only essential for meeting the necessary exchange value, but it also serves as a course of liquidity for the EAT facilitating the Improvement Exchange.
Below are key financing considerations investors should keep in mind during an Improvement Exchange:
- Loan timing and coordination to adhere to strict 1031 timeline
- For full tax deferral the debt on the relinquished property e replaced with new debt, new cash, or a combination of the two
- Maximum loan to value may not work due to the need to roll over all equity for full tax deferral
- Lender should be familiar with the 1031 exchange process to ensure a seamless process
- Specialty exchanges such as Reverse and Build-to-Suit/Improvement will involve lender review of organizational documents for the accommodating company and any special purpose limited liability established
Building or Improving on Related Party Property
Acquiring replacement property directly from a Related Party is generally not permitted in a 1031 exchange. However, an alternative approach allows the Exchanger to enter into a long-term lease on land owned by a Related Party and use exchange funds to construct tenant improvements.
The long-term ground lease and tenant improvements can then qualify as replacement property under IRS guidelines.
The most common forms of Related Parties that this scenario might apply to include:
- Member of the same family unit (spouse, sibling, parents, children)
- Entity where same person or persons own over 50%
- Two entities that are in the same controlled group
Projects Exceeding 180-days
The IRS Revenue Procedure (Rev. Proc. 2000-37) requires that the deal be completed by the 180th after the day the EAT acquired the replacement property on the Exchanger’s behalf. The Rev. Proc. provides what is called a “safe harbor” transaction. If all the terms of the Rev.Proc. are followed (including the dates required), the IRS does not question these transactions.
In practical applications the necessary exchange value often cannot be injected into the project within the 180 safe harbor. Accruit can accommodate a specialty transaction beyond 180 days. Call our team for more details.