The IRS 1031 Exchange
Naturally, most real estate investors are aware of the major benefits of an IRS 1031; however, there are some other benefits that are not quite as well known. One such benefit is the reverse 1031 property exchange, which is a fairly recent development that allows an investor to acquire the replacement property first and then sell the existing property. Since an investor is not allowed to hold the titles to both properties at the same time, a Qualified Intermediary will hold on to one of them, but this does tend to make it a more expensive transaction than a traditional 1031 exchange. This is most beneficial in markets where properties are selling fast, and many potential replacement properties are purchased by other buyers first.
If an investor buys a replacement property of lesser value that the one being sold, then this is called a partial exchange and the investor must pay the relevant tax on the difference in property values. This type of 1031 properties exchange provides flexibility for investors who only want to reinvest part of their capital gains into new, “like kind” property.
Other properties that may qualify under the IRS 1031 include properties owned in the United States, such as a TIC (tenant-in-common) investment property where a large group of investors each own a part of a commercial building. Water and mineral rights along with oil and gas investments may also qualify under the 1031 like kind property exchange.
There are also times when foreign exchanges are considered to be “like kind” properties, such as when the investor exchanges a foreign property for another foreign property. For instance, exchanging a French property for a Canadian property would be allowable, whereas exchanging a U.S. property for a Canadian property would not.
Another possible way to take advantage of the IRS 1031 code is by utilizing improvement exchanges, which are also called construction or build-to-suit exchanges. Using this enables the investor to have a QI hold the title on a replacement property that they have purchased at a value less than the original property. The investor then has 180 days to make the improvements so that the value on the new property will be valued at the necessary amount to receive the full tax deferral.
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