Selling a commercial building at a profit is a great feeling, until the tax bill shows up. Capital gains taxes and depreciation recapture can take a big bite out of your proceeds. That leaves you with less money for your next property. A 1031 exchange can help. It lets you sell one investment property, buy another, and put off paying taxes on the gain. Here are eight basics every Twin Cities commercial real estate investor should know before starting one.
A 1031 Exchange Delays Taxes. It Doesn’t Erase Them.
A 1031 exchange gets its name from Section 1031 of the federal tax code. When done right, it lets you roll the profit from a sale into a new property without paying tax on that gain right away. Your tax bill doesn’t disappear, though. The deferred gain carries over into the new property. You’ll owe it later if you sell without doing another exchange. Many investors keep exchanging over the years, so their money keeps working for them instead of going to taxes.
Only Real Estate Held for Business or Investment Qualifies
Both the property you sell and the one you buy must be held for business use or as an investment. Your home doesn’t count. Neither does a fix-and-flip project you bought just to resell. Since 2018, only real estate qualifies. Equipment, vehicles and other personal property no longer do. “Like-kind” is broader than many people think. You can trade an industrial building in Brooklyn Park for a retail center in Woodbury, or raw land for an office building. Most U.S. real estate can be swapped for other U.S. real estate.
The 45-Day Clock Starts at Closing
Once you close on the sale of your old property, you have 45 calendar days to identify possible replacement properties. You must do this in writing, and the deadline is strict. Weekends and holidays count, and there are no extensions for a slow market. In most cases, you can name up to three properties of any value. There are other options for naming more, but they come with tighter limits. Because 45 days goes by fast, smart investors start looking for replacement properties before their sale even closes.
You Have 180 Days to Finish the Purchase
You must close on your new property within 180 days of selling the old one. That deadline runs at the same time as the 45-day period, not after it. It can also end sooner if your tax return for that year is due first, unless you file an extension. Inspections, financing and title work all have to fit in this window. Commercial deals can hit delays, so building in extra time is important.
You Can’t Touch the Money
This is the rule that trips people up most. If the sale money lands in your bank account, even for a day, the exchange can fail. Instead, you’ll use a qualified intermediary. This is a third party who holds the money from your sale and then uses it to buy your new property. You need to set this up before you close on the sale, not after. Your real estate agent, attorney or accountant usually can’t serve in this role, so pick an experienced intermediary early.
Buy Equal or Greater Value to Defer All the Tax
To put off all of your taxes, the new property should cost at least as much as the one you sold. You’ll also want to reinvest all of your cash proceeds. Any cash you keep is called “boot,” and it’s taxable. Taking on less debt than you paid off can also count as boot. For example, say you sell a building for $2 million but buy one for $1.7 million. You could owe tax on the $300,000 difference. A partial exchange can still make sense, but know the cost up front.
The Title Must Stay the Same
The person or business that sells the old property should be the same one that buys the new one. If your Eden Prairie office building is owned by an LLC, that same LLC should usually take title to the replacement property. Changing owners partway through, such as adding a partner or switching to a new company, can cause problems. Talk to your tax advisor before making any changes to how you own a property.
Local Market Knowledge Makes the Deadlines Easier
The tight timelines are where a 1031 exchange succeeds or fails. That’s why local know-how matters. A broker who knows Twin Cities industrial, retail and office space can point you to properties that fit your goals, including some that may not be widely marketed. They can also help you price your sale and plan both closings. For example, Summerhill helped a client sell an industrial building in Brooklyn Park and buy a larger multi-tenant industrial property in Plymouth through a 1031 exchange. We also took over managing the new property at closing and leased its empty space, bringing it to 100% occupied.
Plan Your Next Move With Summerhill
A 1031 exchange can help you build long-term wealth, but only if you plan ahead and hit every deadline. Summerhill Commercial Real Estate can help with each step. We sell commercial buildings, find replacement properties, and manage industrial, retail and office buildings across the Minneapolis–St. Paul area. That means we can help you sell, buy and run your next investment. This article is general information, not tax or legal advice, so be sure to bring your CPA and a qualified intermediary into the process early. Then call us at 952-473-5650 or contact us to start planning your exchange.