Tips for Avoiding Fed Taxes During Commercial Real Estate Transactions

In the majority of cases, an investor who sells commercial real estate will have to pay taxes on the gains resulting from the sale when the sale concludes. If the real estate has appreciated in value during the time that the investor has owned it, the tax liability resulting from this transaction can be overwhelming and significant.

The Internal Revenue Code published by the IRS, however, does give investors the opportunity to defer tax liability using a 1031 or like kind exchange. This particular section of the Internal Revenue Code outlines that if an investor is able to meet the criteria and uses the proceeds from the sale of a piece of commercial real estate, by buying another property of like kind then this investor is not considered to have received a loss or a gain for tax purposes. Instead, the transaction is seen as a change in the type of investment as opposed to the sale of an investment, thus allowing the investor to defer the tax that would usually be associated with this exchange.

This is a powerful tool for commercial real estate owners and investors. A like kind exchange allows investors to sell appreciated property and then reinvest those proceeds in the purchase of qualifying property without facing an immediate capital gain. While investors may have made a profit on each of these exchanges, they do continue to avoid any tax liability until cash is realized from the sale of a property. This also increases an investor’s buying power by taking money that would otherwise be taxed and allowing it to be invested in the new property.

To put it simply, a 1031 exchange could serve as an interest-free loan from the government for the purposes of reinvestment and allows the investment to continue to grow on a tax deferred basis.

Some of the most important aspects of a 1031 exchange involve qualifying property and the timing of an exchange. The real estate being sold needs to be held as an investment or used for business or in a trade. For example, a primary residence for an investor would not qualify under a 1031 exchange.

In addition, an investor should also be aware of the timing. An individual has 45 days within which to identify a replacement property but the kickoff of that 45-day clock is also the beginning of a 180-day limit for the exchange to close on the second property as well.

Finally, make sure you consult with an experienced qualified intermediary who can accept and apply the funds on your behalf.