If you invest in commercial property that has appreciated in value, and are ready to cash in, you might owe a lot of income tax on this transaction. You can postpone income tax by making a "1031 like-kind exchange" instead of selling the commercial property. F
irst you'll need to find someone who is willing to trade a property for yours. An experienced real estate lawyer can help you with the process.
1031 Exchanges Delay Taxes
In a 1031 exchange, you can delay paying income tax on your property only if you trade it for similar property that you plan on using in a business, or that you will use as an investment. A 1031 exchange can save you a lot of money, especially when your property is worth much more than you paid for it.
If you decide that a 1031 exchange will meet your business planning needs, you should know that there are some important procedures to follow in order to delay your tax payment.
Identify and Exchange the Property
The law requires that you identify a specific property that you will trade for. You need to do this quickly, since the law gives you a certain amount of time to complete the exchange.
Only Like-Kind Property Is Allowed
You must make sure that the commercial property you receive in exchange is like-kind. Properties are like-kind if they are of the same nature or character, even if they differ in grade or quality. The tax law is extremely specific on what like-kind property is. If you end up choosing property that doesn't qualify, you may not have enough time to find another property.
You Will Still Pay the Tax Later
Income tax will be due when you eventually sell the new property. For example, if you paid $20,000 for the original commercial property and then sold it for $50,000, you would owe tax on $30,000 of profit. With a 1031 exchange, you do not.
Ten years later you sell the new commercial property for $100,000. At this time, you will pay tax on $80,000 - because you use the cost of the original commercial property to calculate the profit.
A Real Estate Lawyer Can Help
The law surrounding 1031 like-kind exchanges of commercial property is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a commercial real estate lawyer.