An Incomplete 1031 Exchange may Defeat its Purpose

Rental-property owners often conduct an exchange under IRC Sec. 1031 for one reason: to defer recognition of capital gains.

In order to avoid a taxable event, a client must acquire at least as much real estate as she sold. This includes replacing all of the relinquished property’s prior debt with new debt or additional equity.

However, clients often find a great replacement property that has a lower value than the property they just sold. As an example, suppose client Betty is doing a 1031 exchange, and her relinquished property sold for $1 million net of costs, with a $250,000 gain (let’s suppose there is no outstanding loan). If she finds a desirable replacement for $750,000 and keeps the other $250,000 after the exchange, the entire $250,000 will be taxable, just as if she had never done an exchange in the first place.

Should Betty give up on her chosen property? After all, she may not find anything desirable as a second property to own and manage for only $250,000.

Not necessarily—there are several other options for Betty, including 1031-qualified investment programs designed to accept the “leftovers” or “stub” amounts in an exchange. If you are advising clients in a 1031 transaction, do not let them put highly-taxable dollars into their pockets without discussing all the possibilities with someone like us.

This information is for educational purposes only and does not constitute direct investment advice or a direct offer to buy or sell an investment, and is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Because investor situations and objectives vary, this information is not intended to indicate suitability for any particular investor. The views of this material are those solely of the author and do not necessarily represent the views of their affiliates.

Investing in real estate and 1031 exchange replacement properties may involve significant risks. These risks include, but are not limited to, lack of liquidity, limited transferability, conflicts of interest, loss of entire investment principal, declining market values, tenant vacancies, and real estate fluctuations based upon a number of factors, which may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Investors should also understand all fees associated with a particular investment and how those fees could affect the overall performance of the investment.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). 1031 Capital Solutions is independent of CIS, CAM and CIA.

Upcoming Events

continue reading

Related Posts