Top 5 Misconceptions about 1031 Exchanges

Top 5 Misconceptions about 1031 Exchanges

“Like-kind” means I must exchange the same type of property, such as a condo, for another condo. 

No! Like-kind is the worst term to use in our industry. 1031 exchanges are often called “like-kind exchanges” because that is the language used in the tax code. In reality like-kind means any REAL property. You can sell a single family rental and buy a shopping center or an apartment building or vice versa. You can even sell an office building and buy vacant land. If it’s attached to the ground, there’s a good chance it would qualify as a replacement property.

Doing a 1031 Exchange will only complicate my sale and could scare the buyers or the sellers of my replacement property.

This is very uncommon and usually not even noticeable. There is one paragraph added to the contract letting all parties know, but outside of that, 1031 Exchanges are just an extension of escrow. The whole goal is to not allow the sellers to have constructive receipt of their proceeds. The 1031 Exchange Accommodator will open a trust account on behalf of the sellers to place the funds until they are ready to close on the replacement property. Very rarely would the other party in the transaction even know this was happening in the background.

My attorney can handle the exchange for me as my Qualified Intermediary. Or, my accountant knows all my tax stuff – I’m going to use my CPA as my QI.

No! If the seller’s attorney or accountant has provided any legal or accounting related services (or any service not exchange-related) in the two-year period before the exchange, they are disqualified and may not act as the Qualified Intermediary. 

The capital gain tax rate is only 15%. I’ll just bite the bullet and pay the taxes now. 

This one is always my favorite! 15% is just the beginning and for some investors who have a gain over $244,425 the rate can go up to 20%. This is just the federal rate. Then you have your state which can be another 13%, Healthcare Reform Act which can be another 3.8%, then there’s depreciation recapture! 25% of all depreciation taken (or not taken) is taxed at 25%. The average tax on appreciated real estate is between 25% and 40% depending on what state you’re in. With a 1031 Exchange, you pay ZERO!

All of the funds from the sale of the relinquished property must be reinvested. 

Not necessarily! An investor or exchanger can buy down in value. Or the investor can choose to withhold funds or receive other non-like-kind property in an exchange. But the amount that they buy down, or money they withhold, or any other non-like-kind property received, is considered “boot” which means the exchanger likely will have to pay some taxes. If you hit a homerun and want to take some cash, do it! The best way to keep the IRS away is to pay them a little! It’s not all or nothing in a 1031 Exchange.