What Business Owners Need to Know About 1031 Exchanges
Tax codes are numerous and complex, and they change as frequently as Congress decides is necessary. As a small business owner, it is important to understand how certain tax codes apply to you. For example, if you own an investment property, and you are exploring options to sell and purchase another property, understanding a 1031 exchange is essential.
A 1031 exchange—also called a like-kind or Starker exchange—is a provision for business or investment property that defers the tax gain when swapping one property for another like-kind property of the same or greater value. The IRC Code for a 1031 exchange states: "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like kind, which is to be held either for productive use in a trade or business or for investment."
So what do small business owners need to know about 1031 exchanges? Here are a few basic guidelines:
“Typically, a 1031 exchange is a simple swap of one piece of real estate for another,” said Andy Gesell, Senior Vice President of BankCherokee.
Gesell explained that these like-kind exchanges of real property are what the bank sees most.. Corporate stock and partnership interests may not be swapped under the rules for 1031 exchanges.
A 1031 exchange has a strict 180-day timeline, which begins the day after a business owner sells a property. “The critical time frame is the first 45 days of that 180-day period, because that’s the time you have to designate (or identify) your replacement property or properties,” explained Jeff Peterson, President of Commercial Partners Exchange Company.
Though the timelines are firm, they don’t typically pose a problem for business owners. “In reality, most business owners do the legwork and locate a replacement property before they even initiate the exchange process,” said Gesell.
When you sell a business property, the replacement property must be designated in writing. A qualified intermediary (someone who is not your attorney, agent, broker or CPA) holds the proceeds from the sale and uses the funds to purchase the replacement property for you. This is critical, and required to meet 1031 exchange regulations.
Both the sold and new properties must be held for business or investment purposes, which means you can’t sell your primary residence and buy an investment property. Conversely, you may not sell an investment property and purchase a primary home or a property used primarily for personal use such as a second home or vacation property.
There are additional considerations for more complicated 1031 exchanges, such as those that involve partial exchanges or a cash surplus. No matter the level of complexity, Gesell recommends working with an experienced qualified intermediary who understands the process and implications. “We encourage our small business customers to work with a pro and develop a plan,” he said. “Once we know what their financial goals are, we can help determine if a 1031 exchange is right for their business.”