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How do investors use a 1031 like-kind exchange?

Make a profit on nearly any investment and you’ll need to pay a capital gains tax. This is true if you make your profit in stocks, business ventures or art deals. However you make your money work for you, you’ll need to pay your taxes—unless you take advantage of the 1031 like-kind exchange.

The 1031 like-kind exchange is a special tax loophole that allows investors to take the money out of one commercial real estate investment and roll it forward into another without paying capital gains taxes. As The New York Times recently reported, the like-kind exchange used to apply to a range of investments. It now applies only to commercial real estate.

Six things to know about the 1031 like-kind exchange

If you think that growing your money free of capital gains tax sounds like a good deal, you’re not alone. Commercial real estate investors often use the like-kind exchange to upgrade their investments and to build a legacy of wealth for their heirs. However, there are several important things you should know:

  • Both properties need to be commercial real estate for business use or held for investment. The like-kind exchange isn’t meant for people “flipping” properties.
  • Once you sell your first property, you have a strict, 45-day deadline to name the property—or properties—that you wish to buy.
  • From the day you sell your first property, you have 180 days to close on the new investment property.
  • To avoid paying capital gains tax on the sale of your property, you need to reinvest all the money. You can still bring in new money if you need.
  • Your side of the titles must match exactly from the sale to purchase. It may be wise to make the deals in the name of a business or trust, rather than as partners with another person or persons.
  • You cannot touch the money. You need a qualified intermediary to handle the money between sales. The intermediary also files important documents with the IRS.

Notably, it doesn’t matter if the properties are office buildings, warehouses or undeveloped land. So long as you sell one commercial real estate investment and apply the money toward another, you may be eligible to use the like-kind exchange.

Make your real estate investments work for you

The 1031 like-kind exchange offers many advantages to anyone investing in commercial real estate. But taking full advantage of the loophole needs vision and planning. An attorney can help you gain a better understanding of the different complexities and variations that might apply to your investments.