Real estate professionals are in the ideal position to recommend 1031 like-kind exchanges to their clients when appropriate, according to Margo McDonnell, president and CEO of 1031 CORP., Collegeville, Pa.
“Oftentimes your seller may be unaware of 1031 exchanges and misses the opportunity to buy replacement property with pre-tax dollars,” McDonnell said speaking to PAR President Christopher Beadling during a PAR webinar yesterday. “The actual 1031 must be handled by a qualified intermediary. We handle all of the 1031 details, so the Realtor® can handle all of the details of listing and selling the property and getting them to the closing table.”
“Anytime a real estate professional is listing a property and it’s not the client’s primary residence, you should mention the possibility of a 1031 exchange and urge them to talk with their tax advisor to determine what’s best for them,” McDonnell said. “It’s really important to start these discussions weeks in advance because there are deadlines in place as to when the property transfers must be complete to be eligible for 1031 treatment. Once the client has closed on the sale of their relinquished property, it’s too late to take advantage of this tax deferral.”
A 1031 like-kind exchange gets its name from Section 1031 of the federal tax code. It allows the seller of a business use or investment property to defer the capital gain when exchanging for a replacement business or investment property. It is simply the sale and subsequent purchase of a replacement property linked together by paperwork and completed with the required time periods. A new property being purchased with the 1031 must be identified within 45 days of the closing of their relinquished property and the purchase of the new property must be completed within 180 days. These time periods run concurrently. Any type of property used in a trade or business or held for investment will qualify for 1031 tax-deferral treatment.
Recognition of 1031 exchanges was included in Pennsylvania legislation this year and will take effect on exchanges initiated after Jan. 1, 2023. Pennsylvania was the only state in the country that did not allow 1031 tax deferrals prior to the recent legislation, which the Pennsylvania Association of Realtors® has supported for years. Currently, sellers of Pennsylvania property and Pennsylvania taxpayers can defer the federal gain but must pay Pennsylvania income tax on the gain.
The lack of 1031 exchanges in Pennsylvania has been detrimental to the state. “It has been a big issue,” McDonnell said. “Our company is located in Pennsylvania and half of our transactions include properties in Pennsylvania. But when non-Pennsylvania investors are looking at purchasing a property and consider the future exit strategy, they saw that they would not be eligible for a 1031 exchange treatment if the property was located in Pennsylvania and considered properties in neighboring states.”
A 1031 exchange isn’t just for large commercial properties. “This is one of the biggest misconceptions,” McDonnell noted. “Two-thirds of the clients our company works with are single-family rentals and properties selling for under $500,000. In fact, that’s common across the country.”
“There is flexibility in the type of replacement property you purchase; any real property held for business use or investment can be purchased,” she explained. “For example, if you’re selling a shopping center, you could purchase an office building. Or someone selling a farm could purchase a multi-unit rental property.”
Frequently exchanged types of properties include farms/ranches, vacant land, office buildings, duplexes, single-family rental properties, warehouses and industrial buildings, shopping centers and retail properties, conservation easements, billboard, cell tower and utility easements, tenant-in-common interests, timber and water rights, co-ops and oil and gas royalties and mineral rights.
McDonnell said international property sales are also eligible. “The tax code allows the sale of domestic property for another domestic property and a foreign property for a foreign property. You can’t, however, sell a foreign property and purchase a domestic property.”
The Federation of Exchange Accommodators provides a search for qualified intermediaries at 1031.org.
Realtors® can learn more about like-kind exchanges at NAR.Realtor.
Watch the replay of PAR’s “The Basics of 1031 Like-kind Exchanges” webinar.