Despite the number of investors who take advantage of 1031 exchanges, there are still some common misconceptions that I hear from time to time, in particular, with regards to like-kind properties.
Below are several common myths – and answers – about like-kind properties.
Myth 1: You Have To Buy The Same Kind Of Property In A 1031 Property Exchange
Many people assume like-kind properties mean if the property you’d like to sell is, for example, an office property, that you’re required to purchase another office property.
In fact, the like-kind rule for commercial property is wide-ranging: pretty much any commercial real estate property can substitute for another.
So, if you own a multifamily income property, you can use office, retail, or industrial property as your replacement property. You can even use vacant land.
The IRS explains that the key point is that like-kind properties must be “real” properties. In reality, the like-kind property rules are more of a problem for personal property, which includes various types of tangible and intangible business assets. Personal properties also cannot act as like-kind properties to real properties.
Myth 2: My Lawyer Or Realtor Can Act As Qualified 1031 Intermediaries
Qualified intermediaries must be unrelated to the taxpayer, and they must work for a business that is involved full-time in the 1031 exchanges. Thus, your lawyer, realtor, or accountant cannot act as intermediaries for your exchange.
Myth 3: 1031 Exchanges Mean You Never Have To Pay For Taxes, Ever
When you execute a 1031 exchange, you are only deferring the capital gains tax until the property is sold. However, there are numerous investors who go from one 1031 exchange to the next, essentially deferring the capital gains tax indefinitely.
Myth 4: Income Properties Only Qualify For A 1031 Exchange If They Were Profitable
Many investors assume that commercial properties that showed a profit or cash flow are eligible for 1031. In reality, any property that was held for investment purposes can be used in a 1031 exchange, as long as you have purchased the property with the intent of increasing your income or capital appreciation.
At the same time, investors who purchase commercial properties in order to fix and flip may not use those properties for a 1031 exchange. These properties are considered as being held for sale, and not held for investment.
Myth 5: Like-Kind Means A Commercial Property Can Only Be Exchanged For The Same Type Of Commercial Property
It’s commonly believed that your replacement property must be the same type of property as your relinquished property. So, the thinking goes, if you sold an office building than your replacement properties must also be office properties.
This is actually far from true. In reality, the “like-kind properties” rules state that all commercial properties can be exchanged for each other.
A retail property can be exchanged for an office property, an industrial property can be exchanged for a shopping mall, and raw land can be exchanged for multi-tenant buildings.
Myth 6: Personal Property Can Never Be Used In A 1031 Exchange
This is an interesting myth because I have personally helped several investors do just that.
The key, of course, is using a personal property whose status has been changed from a primary residence to an investment property. As long as the property is used for investment purposes within the last 5 years, and is presently an income property, then you can use property that was previously a primary residence, in a 1031 exchange.
In terms of how long you need to have used the property as an income property, there is no set period of time. You need to show “intent to hold” which is that you had the intention of holding the property for investment.
Myth 7: Boot Is Always Taxable
Most brokers will tell you that any money taken out of the exchange and not used to pay for the purchase of a replacement property (called boot) is taxable, both by capital gains taxes and by a 25% income tax.
While this may be true in most cases, the fact is that there are specific ways that a savvy investor can pull out money from a 1031 exchange, use it for whatever he likes, and not pay taxes.
If you’re interested in finding how you can contact me to find out exactly how. It’s a little-known method that most brokers don’t know about and it’s 100% legal.
However, with over forty years experience in the field, I have become familiar with numerous ways investors can benefit from 1031 exchanges.
Please consult with a certified accounting professional or a tax attorney when planning on a 1031 exchange and check with your own professional team before acting on any advice stated here.
Tags: 1031 exchanges, capital gains taxes, commercial real estate property, Like-Kind Properties, relinquished property, replacement property