You can start planning early for your 1031 exchange.  There are many planning ideas that can result in a smoother process with better results for the exchanger. The accounting, financial and legal nature of the upcoming transactions need to be considered before the initial sale of the relinquished property. The involvement of the exchanger’s team of professionals is suggested to help establish the plan to achieve the goals of the exchanger. Additionally, the exchanger will need to engage the services of a qualified intermediary (QI) to prepare the exchange documents that will comply with the tax code and cause the exchange to take effect. 

To maximize the tax deferral, the exchanger must (1) buy a replacement property that is the same price or greater than the relinquished property (net of direct selling expenses) and (2) use all the cash proceeds from the sale of the relinquished property towards the purchase of the replacement property. Any trade down in value, whether cash withdrawn or financing that is not replaced, will likely trigger some tax burden as a partly tax-free exchange, which is still allowed.  

There are many advantages to a 1031 exchange beyond the obvious benefit of deferring the capital gains tax.  Quality of asset, market conditions, geographical change cash flow increase can all be additional factors driving an exchange.  Some exchangers want easier management, seek to consolidate properties into a larger property, or want to exit or diversify out of a market or location that may be limited in upside potential or ripe for a downturn. The exchange could even be motivated by estate planning or meeting a retirement cash flow expectation. 

An exchanger must assess the various benefits of an exchange and compare them to a traditional sale.  The tax benefits should be weighed against the taxes to incurred from the sale.  Is the taxable gain that is being deferred large enough to justify structuring an exchange?  

The financial information necessary to assess the benefits and have an informed thought process includes adjusted basis, capital gains, tax exposure, equity, and debt.  Consider that an exchange requires the use of the equity, as well as a requirement to take out an equal amount of debt as was paid off on the sold property (or replacing that amount with new cash), to re-invest in the replacement property. 

The main advantage to consider is that the tax deferral allows the exchanger the ability to purchase “more” replacement property with funds that would have otherwise been used for capital gains tax on the initial sale.  The exchanger can also leverage such funds to substantially increase their purchasing power and wealth building potential. 

The result of these thoughts and calculations will provide the exchanger with the insight necessary as to the merits of moving forward or not with a 1031 exchange.

Directrust℠ LLC dba Directrust℠ 1031 exchange services does not provide legal, investment, or due diligence services.  Nothing contained herein shall be interpreted as investment, legal, tax or financial advice.  Directrust℠ 1031 exchange services role as qualified intermediary (QI) is limited in scope by only acting as a qualified intermediary within the meaning of IRS regulations section 1.1031(k)-1(g)(4) for federal and state income tax purposes.  2022 Directrust℠ 1031 exchange services, all rights reserved.