1031 Exchange - Tax Saving Opportunities for Investors
A 1031 exchange is a non-taxable transaction in which investors can defer capital gains tax on qualifying, like kind property involved in the exchange. An investor may sell a qualified, like kind property held for business or investment purposes and defer the capital gains tax if another investment property of equal or greater value is bought within a certain period of time.
Under Revenue Procedure 2002-22, investors may sell a partial ownership interest in commercial real estate or other investment property, known as a tenancy in common interest or a TIC interest, and defer the capital gains tax on the sale in a Section 1031 exchange. This tax deferred treatment is available for the exchange of a TIC interest in property held as a real estate investment only if the following requirements under Section 1031 are met:
1) One investment property must be exchanged for any other type of real estate investment property. An investor may not defer the recognition of capital gains on property not held for investment purposes, such as by exchanging a personal residence for an apartment building.
2) The cost of the replacement property must equal or exceed the value of the property being exchanged.
3) If any property or cash is received in the exchange that is not qualified, then a recognized gain will be taxable to the investor.
4) An investor must identify a replacement property within a period of 45 days and receive title to a replacement property within the earliest of 180 after the sale of a qualifying property or the due date of the investor’s tax return in the year of the sale.
One difficulty with executing an exchange prior to Revenue Procedure 2002-22 was that title to the replacement property had to be received in the same form of ownership as the property being exchanged. Under Revenue Procedure 2002-22, investor’s can now exchange a partial ownership interest in commercial real estate or other investment property, known as a tenancy in common interest or a TIC interest, and defer the capital gains tax on the sale in a Section 1031 exchange.
To qualify under Revenue Procedure 2002-22 and defer the capital gains tax on the sale of a tenancy in common interest or a TIC interest in a Section 1031 exchange, there are fifteen requirements that must be met. Investor’s interested in a tenancy in common exchange should seek the services of a qualified intermediary who facilitates a 1031 exchange.
Revenue Procedure 2002-22 has expanded the market and the tax saving opportunities for investor’s. By establishing that tenancy in common ownership interest’s may qualify for an exchange, investor’s have more opportunities to identify suitable replacement properties within the 45 day limit and take title to the property within the 180 day limit. In addition, TIC ownership interests permit investor’s to acquire much larger properties, such as a partial ownership interest in an office building or shopping center, including multiple TIC interests in different geographical areas. One advantage of a partial interest in a larger complex versus independent ownership in this regard is the potential benefit of diversifying properties over a wider geographical area thereby increasing the security and the value of the real estate investment.
The use of like kind exchanges in a non taxable
transaction involving investment property has been increasing as a
result of more liberal Revenue Procedure allowing investors to sell a
partial ownership interest in real estate. The potential tax savings
involving the exchange of qualifying, like kind property can be
substantial. Even in a lower capital gains tax rate environment, the
time spent to successfully complete a Section 1031 exchange for tenancy
in common interests may be worthwhile. Being able to identify and
obtain title to a replacement property with the specified period of
time may be one of the most significant benefits of a TIC exchange.
Return from 1031 Exchange to Financial Planning