1031 Exchanges: Hidden Dangers to Watch Out For

Strong suggestion, be very wary of 1031 tax deferred exchanges. Going forward, you’ll want to proceed with caution when using 1031 exchanges as an investment tactic. From the possibility of new government regulations to a shortage of inventory to invest in, and the restrictive timelines required by IRS regulations, there’s never been a better time to have an experienced exchange Broker on your side.

Hidden Dangers for 1031 Exchangers:

Pending Restriction of Allowed Capital Gain Deferral

• President Obama’s Administration has proposed that no more than $1,000,000 in capital gains may be deferred by a tax payer in one year.

Result: If that restriction becomes law, then 1031 exchanges may still be beneficial for smaller investors and business property owners, but may lack much benefit for larger investors or owners who have had numerous exchanges in their chain of ownership.

• The House and Senate have both recommended the complete elimination of the 1031 tax deferred exchange. Again, neither of the proposed changes are in effect on the date of this article (3/17/15), but be aware that tax law change is in the air, and act accordingly.
• Problem: If you agree to sell with the anticipation that you can avoid capital gains taxation, then make sure what you are doing NOW.

Shortage of Available Inventory

Over the past three years, large amounts of wise money has sought out well located quality passive investment property held for the generation of cash flow, equity growth, and value preservation.

Results for the Exchanger:

• There are fewer good replacement properties to choose from.
• If you can’t secure the Replacement Property in the initial 45 days, you are at huge risk of having to either select inferior properties offered at unattractive prices; or,
• Pay the capital gains tax. If you pay the tax, then try to get back into an investment property with a substantially less amount of equity, you will then discover the magnitude of your error

Basic Lack of Understanding of the Rigid Time Line

The extremely tight timeline is absolutely unforgiving.

• Violate one of the five rules, and pay the capital gains tax.
• These rules are outlined in detail on the www.1031guru.com section of my website.
• Planning for the exchange should occur months prior to the sale of the relinquished property.
• A commercial broker with exchange expertise is invaluable.

Your Best Protection: Use an Experienced Exchange Broker

Step ONE: Meet With a Very Experienced Real Estate Exchange Broker

• There is no substitute for experience in envisioning, structuring and then completing the 1031 tax deferred exchange.
• You can not afford “amateur night” when your equity is at stake.
• Interview the selected broker for necessary expertise and their market access to those properties that you seek to exchange into.

Step TWO: Understand Your Situation

• Which of your properties will be sold to create the exchange opportunity?
• How much capital gain and capital gain tax will exist if sold at the forecasted sale price?

Step THREE: Have a Well-Formed Game Plan

• What investment benefits do you seek in a replacement property?
• Define the amount of available net equity that will exist from your sale
• Define how much debt is to be replaced
  • Interview the best mortgage broker well in advance of the beginning of the 45 day ID Period.
  • Understand any limitations or restrictions that may interfere with completing the exchange.

Stride forth with vigor!

Robert W. Nelson, CCIM, CRE

Real Estate Investment Broker and Counselor

46 years of real estate exchange experience

Pacwest Real Estate Investments, LLC