1031 Exchange Rules & Practices
The increased returns from a 1031 exchange can be substantial. For a small price range example, if you sold a property for $1,500,000 without doing a 1031 exchange, paid off a $500,000 loan and the taxes due are only $150,000, you will have $850,000 to reinvest. If you did the same transaction as a 1031 exchange, you would have the full $1 million to reinvest. You have an extra $150,000 to reinvest. If the cash-on-cash return on the replacement property only averages 10% per year over the next 5 years, the difference in cash flow alone over the next 60 months is $75,000. The larger property also offers added returns from increased principal reduction, increased appreciation from inflation and larger profits when you sell the property.
I've consistently learned valuable best practices from advising hundreds of investors through the 1031 exchange process over the past 30 years. Here are my top ten.
- Engage an attorney and a 1031 intermediary to assure 1031 compliance.
- Begin looking for replacement property early. Start at the latest by the first day your relinquished property goes under contract. Do not wait until the closing.
- Engage a broker who specializes and is knowledgeable in your preferred property type as early as possible, preferably before you start marketing your relinquished property.
- Make sure your broker has proper property search systems, research, and property owner databases needed to effectively identify as many replacement properties as possible and provide advice on the property type and market area.
- Ask your broker to utilize a team of brokers assisting in the search to provide a larger choice of replacement properties.
- In the beginning, set up an in-person or phone appointment with your broker at the same time every business day while you are looking for replacement property. This will help keep the process in a high priority mode.
- Do not use the 45-day identification period as your deadline to have replacement property under contract. You should complete all or as much due diligence as possible on any potential replacement properties prior to the ID deadline. What if my advice to you after due diligence is to not buy the property? You want time to pick another property.
- Understand the offer form or purchase and sale agreement you will most likely use when making offers up front. Do not wait until you find a suitable property to consider an offer format.
- When possible make offers in a purchase and sale agreement format rather than a letter of intent. This may save time and keep your letter of intent from being shopped.
- Proactively make offers on appropriate properties even if they are over priced. If the property works, don't be shy about making an offer that makes sense. You never know, maybe they will negotiate a reasonable deal. If they don't, move on.
Michael Bull, CCIM
Instructor, Commercial Agent Success Strategies
Host, America's Commercial Real Estate Show
Broker, Bull Realty Asset & Occupancy Solutions
Michael@CommercialAgentSuccess.com 404-876-1640 x 101