Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

When President Trump signed The Tax Cuts and Jobs Act into law on December 22, 2017, the real estate community breathed a collective sigh of relief—Internal Revenue Code Section 1031 was preserved for exchanges of real estate.

Long before the introduction of Paul Ryan’s “A Better Way” on Tax Reform in June of 2016, IRC Section 1031 was in the crosshairs of Congressional lawmakers intent on enacting comprehensive tax reform that was simpler, fairer, and more efficient. With a lot of hard work (and a little bit of luck) a broad coalition of stakeholders successfully conveyed the message, on the Hill and elsewhere, that Section 1031 is a powerful capital formation tool and an incredible economic stimulator.

IRC Section 1031 allows an owner of real estate that is held primarily for investment, or for use in a trade or business, to exchange that property, in a tax-deferred manner, provided the owner meets specific regulatory and statutory requirements.

First, the properties must not be personal use property or property held primarily for sale. In some instances, property that has some personal use—like a vacation home—may be eligible for tax-deferred treatment if the personal use is minimal (see Rev. Proc. 2008-16).
Second, the properties must be like-kind to each other. In the real estate universe, all real property is like-kind to all other real property. Industrial property can be exchanged for multi-family property; office buildings can be exchanged for strip centers or even vacant land. Third, the transaction must be structured as an exchange of one property for another, as distinguished from a sale followed by a re-investment. If you close on the sale of your manufacturing facility, retail shopping center or multi-family property and simply walk away with the proceeds, you will have a taxable sale and not a like-kind exchange, despite your best intentions.

Engaging the services of a Qualified Intermediary (QI) is crucial to ensuring your transaction is structured correctly. The QI will provide documentation and guidance throughout the process to ensure you meet the safe harbor requirements for a tax-deferred transaction. Specifically, replacement property must be formally identified within 45 days from the date the old property is sold. Additionally, replacement property must be acquired within 180 days from the date the old property is sold. There are no extensions or exceptions to these statutory rules.

Section 1031 is indeed a powerful wealth preservation tool. Many families build their fortunes on investment real estate. As an asset class, real estate is also great for risk diversification as well as for providing current income. Doing a tax-deferred exchange enables investors to continuously trade up in value and grow their portfolio of assets. For older investors looking to get out of active real estate management, there are plenty of passive real estate investment opportunities in the form of Delaware Statutory Trust interests or syndicated tenancy in common interests, that qualify as like-kind property for purposes of Section 1031.

Investors can continue to exchange properties, rolling the gain from one piece of investment property into the next, and deferring the gain recognition until property is finally sold in a taxable transaction. Finally, no matter what an investor’s tax basis is in the property at the time of death, heirs who inherit property receive a stepped-up basis, resulting in elimination of taxable gains.

 

Article contributed by Mary Cunningham, President and CEO of Chicago Deferred Exchange Company, a Wintrust Wealth Management company.