Landowners hold land for a variety of reasons including conservation, investment, cash flow and personal enjoyment. When intrinsic values change, it may be time to consider selling. If the intent is to replace current holdings with another type of real property, landowners can save money by using a tax deferment tool, also known as a 1031 exchange. Within the scope of eligibility for tax deferment, landowners have multiple replacement options such as building on land already owned, buying land and constructing improvements, replacing with single tenant, triple net leases such as CVS Pharmacy, Walgreens and a sale leaseback.
What Section 1031 Says
According to the Internal Revenue Code Section 1031, “no gain will be recognized on property held for productive use in business or investment when exchanged for like kind property held for productive use in business or investment.” Property denotes real and personal property. Real property is any type of real estate that is considered real property by the state. Examples of like kind real property exchanges include:
- Some states recognize perpetual water rights as like kind to a fee interest in real property
- Farmland is exchangeable for a tenants in common interest in commercial buildings
- 30 year leasehold interest or more is considered real property.
Tangible and intangible personal property held for the proper intent is also eligible but must be exchanged for like kind or like class personal property. Examples are:
- Unallocated gold bullion for Canadian maple leaf gold coins
- Furniture for furniture
- Half-blood heifers for three-quarter heifers
- FCC television licenses for FCC radio licenses.
Each of the replacement options share a likeness of physical properties, character of title conveyed, rights of the parties and period or duration of interests.
Replacement Property Options
Landowners can consider the following replacement options when selling real property:
Build on Property Already Owned
An Exchangor can acquire constructed improvements given the property is purchased from a third party as in a leasehold improvement exchange. The Exchangor cannot acquire property from himself in a 1031 exchange. The IRS does not recognize labor and materials as like kind to real property. Adequate planning is required at least six months prior to initiating this type of exchange unless the land is owned by a related party.
Improvement or Build to Suit Exchange
Property with improvements constructed to the design specifications of the Exchangor satisfies Section 1031 requirements given the property is transferred in exchange for other real property of equal or greater dollar value. A tax is triggered on the difference should the new property be of less value to the old property.
Single Tenant Triple Net Lease
The replacement property is either a new or existing commercial building with a tenant such as a CVS Pharmacy or like tenant who leases the property and is responsible for insurance, utilities and taxes.
A sale of the Exchangor’s property is followed by a 30-year leaseback of the same property and subsequent purchase of a replacement property. This allows the Exchangor to sell his real property, retain use, and reinvest sales proceeds in a replacement property while deferring the capital gain and or recaptured depreciation taxes.
Exchangors are advised to seek the counsel of their legal, tax and real estate professionals prior to engaging in options described to understand the tax consequences and state statutes.
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