The ABC’s of 1031 Real Property Exchange Transactions

By Rana M. Gorzeck

Now that the U.S. economy has improved and the commercial real estate market is thriving, income producing properties are being bought and sold again with increasing regularity. We are currently witnessing a revival of 1031 exchange transactions at our firm. As an example, an office building which had been held for over thirty years by a family was recently up for sale. The problem was that the office building had increased in value exponentially. The looming threat of capital gains taxes once the sales proceeds were to be received by the family was daunting. The family consulted our firm and was relieved to hear that there is a legal way to defer the capital gains tax using the 1031 exchange process approved by the IRS.

Section 1031 of the Internal  Revenue Code  permitted the family to defer the large tax due and exchange the office building, their “relinquished property”, for two other properties which were “like kind assets”, that is they were also commercial real estate properties that were income producing. 1031 exchanges can be used for any size investment properties:  from small income producing properties, such as a rental home, to larger income producing properties, such as an apartment complex or office building, or a “triple net investment”, a real property that is occupied by a tenant with a business, such as a drugstore, restaurant or bank which pays for all the operating costs of maintaining the real property, such as the taxes, insurance and maintenance costs.  The new property or properties to be acquired are the “replacement properties”.

The key is to follow the rules carefully with an experienced attorney to guide you through the process. You will also need to choose an independent 1031 intermediary who will act as the escrow agent to hold the sales proceeds when the closing of the relinquished property occurs until you purchase your replacement property or properties. Since it is imperative that the initial sales contract contain language agreed by the parties that a 1031 exchange is anticipated and setting the requirements for permitting the 1031 exchange, it is critical to hire an attorney to assist you before you begin the negotiation and preparation of the purchase and sale agreement, known as the “PSA”.

Over our twenty seven year history, the commercial real estate attorneys at Ward Damon have closed many different types of commercial real estate transactions for our clients. Should you have the need for the deferral of taxes on the sale of your income producing commercial real property, we would be happy to consult with you to discuss your proposed 1031 transaction.

Rana M. Gorzeck is a partner at Ward Damon, a mid-sized real estate and business oriented law firm serving all of South Florida, with offices in Palm Beach County.  She focuses her practice on commercial real estate matters.  She can be reached at 561.842.3000, or at rgorzeck@warddamon.com.

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