1031 Exchange

Section 1031 exchanges provide investors with one of the best tax strategies for preserving the value of an investment portfolio.  By using an exchange, the investor is able to defer the recognition of capital gain taxes that would otherwise be incurred on the sale of investment property.  The investor can then use the entire amount of the equity to purchase substantially more replacement property.

To qualify as an exchange, the relinquished and replacement properties must be qualified as “like-kind” properties and the transaction must be structured as an exchange.  Using AEX as the “Qualified Intermediary” will provide the investor with the necessary reciprocal transfer of properties to create the exchange and the “Safe Harbor” protection against actual and constructive receipt of the exchange funds as required by § 1031.

General Rule: To avoid paying capital gain taxes in an exchange, the investor should always attempt to:

• Purchase like-kind property that is equal or greater in net sales price (value);
• Reinvest all of the net equity in replacement property; and
• Obtain equal or greater debt on replacement property.

Exception to the General Rule: A reduction in debt can be offset with additional cash from the exchanger, but increasing debt cannot offset a reduction in exchange equity.

To qualify as “Like-Kind” property for a § 1031 exchange, the investor’s relinquished and replacement properties must be property that has been and will be held for productive use in the investor’s trade or business or for investment.  Properties that may qualify as like-kind properties include retail, apartments, mixed use, rental homes, vacant land, agricultural land, office and manufacturing.

• If you plan to sell a property and buy another one for business or investment, then a § 1031 exchange allows you to preserve capital.  Rather than investing after-tax proceeds from the sale of the current property, you reinvest all net proceeds.
• A § 1031 exchange can help you increase cash flow from your investment.  You can convert a non-cash producing piece of real estate into a productive commercial property.
• A § 1031 Exchange can help you consolidate or diversity your real estate holdings.

AEX Corp. is designated as a “Qualified Intermediary” for § 1031 exchange transactions.  The most commonly used safe harbor in § 1031 exchanges is the use of a Qualified Intermediary (QI).  The QI cannot be someone with whom you have had a business or family relationship.  You must use an independent organization whose only contact with you is to serve as the QI.  Importantly, the QI must hold your proceeds from the sale of the property in order to have the transaction qualify as a § 1031 exchange.  If you have actual or even constructive possession of the proceeds (i.e., control of the money without actual possession), the transaction is taxable to you.

The gain, not the profit or equity, from the sale of investment property is subject to the combination of capital gain taxes and the tax on recapture of depreciation.  It is possible for an investor to have little or no equity or profit upon sale and still owe capital gain taxes.  Investors should consult with their tax or legal advisors prior to entering into an exchange.  This formula is a guide to estimate the potential capital gain tax deferral.