TheLandJournal.com

Most people know that it is possible to exchange one form of real estate for another, but few people realize how very useful Internal Revenue Code Section 1031 can be. Like-kind exchanges are such a valuable way to maximize the value of your investment in real estate that anyone buying or selling rural land should keep this option foremost in mind. Section 1031 is an amazingly useful tool in so many situations:

• Are you planning to retire from your rural land and switch to owning rental units?

• Or would you like to get out of rental property and into a special piece of land?

• Do you own land now, but have you found a piece of land that you like better?

• And is it perhaps in a far-distant state?

• Or would you like to trade some investment property for a second home or a retirement home?

• Or perhaps do you just want to harvest the value of your real estate and go to cash, but you wish that you could do it over more than one year?

If you answer “yes” to any of these questions – or to a literal host of others – then before you sign on any dotted lines, you ought to talk with an attorney who is knowledgeable about Section 1031.

Essentially, a like-kind exchange is the switching of one piece of investment property for another through the use of an intermediary. All the rules must be followed strictly, but if they are followed then any capital gain on the property sold can be rolled forward into the property that you buy without your having to pay capital gains tax. Think about what this means! Rather than having to pay a tax which in some states hovers beyond twenty percent of the gain, you can use that tax money to buy more real estate. Even sliced bread never looked so good!

We can’t give you tax advice so you will have to consult your own advisers, but here is some general information to help you decide whether a like-kind exchange might work for you:

• All kinds of investment real estate are eligible for Section 1031 treatment. You can easily shift from apartment houses to rural land or vice-versa.

• Real estate held for personal use is not eligible for Section 1031 treatment. So if you hope to trade into or out of a personal residence, you will have to convert that property to rental use either for a few years before you sell it, or – if you are buying – then for the first few years after you take title to it. In general, two years of investment use has been considered to be sufficient to make the conversion successful, but be sure to follow your own attorney’s advice.

• Sales proceeds cannot touch your hands. This means that you will need to hire an eligible intermediary before you make your sale. The intermediary signs your p&s and accepts your sales proceeds, and then it takes title to your new property before transferring that property to you. Most real estate attorneys can recommend a good professional Section 1031 intermediary.

• The cost is generally modest. The typical intermediary will charge you just a few hundred dollars, plus maybe $500 or less per property; so if your chosen intermediary charges more, consider shopping around.

• Reverse exchanges are possible. Let’s say that you have found the land of your dreams, and you’ve got to take title to it now, but your old land hasn’t yet sold. Your intermediary simply takes title to the new land using a bridge loan which you have guaranteed, and then it holds your new property until it is eventually able to close on the sale of the old one. The sales proceeds pay off the bridge loan, and there you are: the intermediary transfers the new land to you. And if you need to use the new land before the old land sells, then your intermediary can simply lease it to you.

• Breaking up the land that is being purchased or sold is possible. For example, if you now reside on your land and you want to roll just the value of your land into some new investment property while you use the personal residence exclusion to shelter the expected gain on your home, then in most states you can divide the parcel fairly inexpensively and use Section 1031 to roll the value of the land portion into another real estate investment. Be careful, though! If you subdivide too liberally, you might inadvertently convert yourself into a real estate developer for tax purposes, and developers aren’t eligible for Section 1031 treatment.

• Switching to a commercially-managed income investment is possible. Since so many people are using Section 1031 now, an industry has sprung up around tenants-in-common investments into which exchangers are able to transfer their sales proceeds without paying a current tax. These investments vary a lot, but in general they will own one or more large properties which are expected to be sold within a few years’ time; and meanwhile, many of them will pay you income. We know of some tenants-in-common investments which have been spectacularly successful, but we also have seen some genuine dogs, so be careful and get good expert advice. If you hope to realize your expected capital gain over several years of time, and you meanwhile hope to earn an income stream, then ask your attorney or your intermediary to help you investigate this option.

Once again, we’ve got to emphasize the fact that none of what we say is tax advice! We are just trying to help you glimpse the possibilities, and if you like what you see here then find an attorney who can help you in your own specific situation. Nobody likes paying taxes, but Section 1031 is one part of the Internal Revenue Code that anybody can love!