By Rider Stoglin
For almost exactly 100 years, one of real estate’s best attributes causing an incredible amount of capital to be invested in the asset class, has existed. That vehicle? Like-kind exchanges, also known as, a 1031 exchange. In this short article, we will briefly explore the definitions of like-kind exchanges, the history behind them and provide an understanding of what’s on the table for like-kind exchanges in the weeks to come.
Dating back to 1921, like-kind exchanges have held their place in our tax code. An investment strategy used by people of all levels of wealth, the strategy provides an opportunity to defer capital gains under a specified process and certain guidelines by trading into a like-kind asset and placing the capital gains into a new property. The argument for 1031 exchanges is that they spur investment, and they keep owners of assets investing back into the community. Critics of the 1031 exchange practice suggest that this part of the tax code has turned into a multibillion-dollar giveaway and that if the capital gains were taxed now, that money could be used elsewhere.
The way that these like-kind exchanges work is that if someone owns a property and decides to sell it years later, they can sell their current asset. Once their current asset is sold, the seller has 45 days to identify a potential replacement property and 180 days to complete their acquisition process of the new property.
So, what is considered a “like-kind” asset that would qualify? Notoriously, all real properties are typically like-kind, regardless of type of property is being exchanged for another. For example, the owner of a shopping center could sell his or her property in exchange for raw land, or even a ranch. That said, all like-kind exchanges must be for investment, and cannot be for personal use. And it goes without saying (or should) that exchanging property in the United States for property outside of the United States would not be considered like-kind.
With this background knowledge regarding like-kind exchanges, what is at stake for the 1031 tax rule at the time of this article?
Under a new plan set forth by our current administration, like-kind exchanges would be limited substantially, but not eliminated. The limitations come in the amount of tax deferral that would be permitted which would be limited to $500,000 annually for individual taxpayers and $1,000,000 for those filing a joint tax return. Until the $3.5 billion budget reconciliation bill is written, we won’t know whether the new plan for 1031 exchanges will go into effect.
In the meantime, it’s an interesting concept for building owners—whether owner-users or traditional investors—to consider the sale of their property so long as to defer capital gains on their property possibly one last time.
The argument to keep like-kind exchanges is strong, and the current administration is not the first to propose changes to the 1031 tax rule, but it begs the question as a current property owner… what should I do right now? As with every real estate transaction, we recommend speaking with a trusted tenant and owner-user representative to explore all options including a sale or a sale leaseback.