There is a good reason why commercial real estate has remained a popular source of investment for investors for decades. It is a relatively safe and secure form of investment that generates income passively. That is the obvious reason though, and not the only cause of popularity.

Commercial real estate also has several regulatory provisions that allow investors to benefit from having this kind of investment added to their portfolio. Ever heard of the 1031 exchange? If you have been reading up on commercial real estate, the term probably came up.

It’s now time to explore what it means.

What is the 1031 Exchange?

The 1031 exchange allows investors to exchange one property with another of about equal or better value without having to pay capital gains taxes on it.

How Does the 1031 Exchange Benefit Commercial Real Estate Investors?

There are ample reasons why the 1031 exchange works well for real estate investment. However, the best reason is that it cancels an additional charge the sellers would have otherwise incurred.

The provision allows them to keep conducting business smoothly without affecting their cash flow.

The 1031 Rules

Does the 1031 sound ideal? It is; however, it comes with some prominent rules and regulations attached.

  1. The 1031 rule only applies to like kind properties — Both the properties need to be real estate-related for 1031 exchange to work.
  2. Even within real estate, the properties need to be similar in terms of their value or the seller must choose a better (up to 200% of the one sold) property.
  3. Prior to  the sale of the property, up to three (3) properties can be identified  within 45 days and purchased within 180 days.

You will need to abide by these rules to qualify for the 1031 exchange.

Additional Details

In addition to the rules mentioned above, also take the following aspects into account.

Qualified Intermediary

Since any income from the exchange is taxable, you will need to work with a qualified intermediary for a 1031 exchange. The intermediary will hold your income until you finalize the exchange property and will give it to the seller of the new property you are acquiring.

Depreciation Recapture

Properties depreciate and this depreciation percentage is used in property assessment each year, striking down the overall value of the property. However, when you sell the property, you would ideally sell it for an amount higher than the amount you paid initially.

Due to depreciation, your taxable income from the exchange increases. Since you can only choose a property that is 200% of the existing value of the property you are selling, any amount that remains during the exchange would be taxable.

Conclusion

Overall, the 1031 exchange policy is extremely beneficial for commercial real estate investments due to its tax benefits. So long as you abide by the rules, the provision will help you maintain a good stream of profitability in your portfolio.

If you are looking for commercial real estate in Rio Grande Valley, please contact us. We have years of experience in commercial real estate in the region and will ensure you find the best properties.