From First Tuesday
Further, properties transferred –– exchanged –– between related persons in a §1031 transaction must be held by both persons for a minimum of two years after acquisition. Only then do business-use properties qualify as §1031 property for resale on a cash out or further §1031 reinvestment. [IRC §1031(f)(1)]
The benefits and advantages opened up to real estate investors by a §1031 reinvestment plan include:
- the avoidance of reporting all or a portion of the profit on a sale;
- the purchase of higher-valued, more efficient real estate with a greater income yield than the real estate sold, funded by an increase in mortgage debt or cash;
- an increase in the annual depreciation deduction by purchasing a higher-priced replacement property and setting a new allocation of basis to depreciable improvements;
- an inflation hedge to take maximum advantage of an anticipated rapid increase in cyclical real estate values by purchasing highly leveraged property to replace a lower-leveraged property;
- a consolidation of equities in several properties, held by one or more owners, into a single, more efficient property;
- the sale of a high-valued property and the purchase of several replacement properties, each of lesser value than the property sold, to either reduce the inherent risk of loss by diversification or facilitate an orderly liquidation of a single asset over a period of years;
- the tax-free receipt of cash from a sale when the purchase of a replacement property is financed by the execution of a carryback note in part for payment of the price;
- the replacement of a management-intense property with a more manageable property; and
- the relocation of the equity in a property, undiminished by taxes, from one geographic location to another by an investor who themselves move or determines another location offers a better investment opportunity.
The sale of §1031 property is the first step in a reinvestment plan designed to maintain a continuing capital investment in §1031 real estate. Remember, for business-use property to qualify as §1031 property, it must be owned for one year prior to its sale.
To ensure the investor has the ability to complete a §1031 reinvestment by purchasing replacement property, the agreement to sell, grant an option or exchange, prepared to document the investor’s sale transaction, needs to include:
- a provision stating the buyer agrees to cooperate in a §1031 transaction [See first tuesday Form 159 §10.6 ]; and
- supplemental escrow closing instructions, worded to prevent the investor’s receipt of the net sales proceeds on closing and signed by the buyer. [See first tuesday Forms 172-2 and 173-2]
The second step is the location and acquisition of a replacement property. The investor enters into a purchase agreement with the seller of the property that will become the replacement.