1031 Exchange: Basics + Best Practices In Today's Market
Q&A with Teresa Fluegel: Executive Vice President of Chicago Deferred Exchange Co. & the Bay Area’s trusted Certified Exchange Specialist®
In today’s market, East Bay landlords are exploring whether to buy, sell and/or leverage. Because of this trend, it seems like the perfect time to share our Q&A with Teresa Fluegel, Executive Vice President at Chicago Deferred Exchange Company (CDEC) & one of the most dynamic Certified Exchange Specialists® in the San Francisco Bay Area.
On a personal note, Teresa and I have known each other since my first year in real estate (2005). Over the years, we have completed multiple transactions together, both for the LOH family portfolio and for our valued clients.
Together, we are actively involved in various industry organizations, such as CREW East Bay (Commercial Real Estate for Women), CIRE (Chicks in Real Estate), Apartment Brokers Only and more. We hope these insights provide value, and we encourage you to reach out if you are thinking of buying, selling and/or leveraging.
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What qualifies for a 1031 exchange? Any type of real property that is held for investment or for use in a trade or business. A primary residence, a second home and an interest in a partnership do not qualify for tax deferral under Section 1031.
What are typical scenarios for a 1031 exchange? Investors exchange real estate for a variety of reasons. The primary reason is to defer current gain recognition on the sale of their old property.
Section 1031 is also used for estate planning purposes. Every exchange is unique depending the goals of the investor. An investor may want improved cash flow as they enter retirement, or an investor may want to exchange into property for greater appreciation, pride of ownership, owner/user may want to operate their business in the property or want a larger or smaller facility, or better location, invest in a different state. An investor may want to diversify their entire real estate portfolio for better overall performance. They may eventually want to retire in the property and change it from investment property to a primary residence.
What preparation advice can you provide for someone considering a 1031 exchange? Keep in mind that you will need to make decisions throughout the process of selling and purchasing investment property within a required timeline. You need to have a team of experts to help you with this process, including your CPA to see what your potential taxable gain is if you are considering selling investment property; and a real estate and/or tax attorney to help with any entity formation, changes, corrections to update legal title to your property, review purchase and sale agreements, etc. Always utilize a real estate broker who understands investments to help you with achieving your goals.
Most importantly, when you are considering a 1031 exchange, call the 1031 Qualified Intermediary directly to help you understand the process, requirements and time line to complete the 1031 exchange. The IRS has very specific timelines under Section 1031 to complete an exchange.
Are there any common misconceptions about 1031 exchanges? A couple most common misconceptions about 1031 exchanges would be often times investors don’t realize they can exchange vacant land which does not produce any income into incoming producing property as follows: single family rental property and/or residential or commercial condos, multi-family property, shopping centers/strip center, industrial, retail, office properties, timberland, single tenant, triple net leased property, tenancy in common interest, beneficial interest in a Delaware Statutory Trust, existing leasehold interest with 30 years or more to run.
Are there any best practices/advice specific to family-owned portfolios? Both family-owned and business-owned portfolios need to work with a CPA Firm that specializes in real estate and tax in order to help them with strategic planning as it relates to overall optimum performance of the entire portfolio. There are many new tax laws under The Tax Cuts and Jobs Act of 2017 that investors and business owners should be aware of from. Consulting with a real estate attorney and/or tax attorney is always beneficial along with an estate planning attorney who can draft a trust are all best practices when you own investment property.
How long can my taxes be deferred? Taxes can be deferred until you sell the property and do not do a 1031 exchange, or when upon your death if your estate planning is completed your heirs should receive a stepped up basis at that time.
What if I own in a partnership or an LLC? Under the IRS regulations for Section 1031 requires an investor to take legal title to the purchase property the same way they hold legal title on the sale property. You would discuss with your CPA the best way to hold legal title to property based on what the tax ramifications are for the tax entity you choose. There can be pros and cons on different entities depending on if you are individual or corporation.
What is drop and swap vs. swap and drop? It is a term used to describe changing the entity of the legal titleholder when you want to do an exchange. The LLC drops out to tenant in common interest then swaps into another property as tenants in common.
The swap and drop is a transaction where the investor purchases in the LLC then after the investor acquires new property in the same LLC – the investor would drop out to tenancy in common interest. This can be helpful if the investor is buying multiple properties for different owners. This always has to be discussed with the investors CPA/Tax Advisor and/or Real Estate/Tax Attorney.
The IRS and CA-FTB-Franchise Tax Board do not look favorably upon this change of ownership right before selling investment property as they look at the intent to hold property for investment for some period of time to establish intent. It is a good idea if you are considering selling investment property that you discuss this sooner than later with your tax advisor.
What happens if I buy before I sell? If an investor needs or would like to acquire property before selling investment property they have the option of doing a Reverse Exchange. The Qualified Intermediary would need to be involved prior to the close of escrow on the purchase.
In our role as the Exchange Accommodation Titleholder [EAT] we take legal title to the purchased property at the close of escrow and park the property in the exchange for up to 180 calendar days while the investor sells his existing property. If the investor cannot sell his existing sale property within the 180 calendar days there would not be any capital gains tax because there was no sale only a purchase of property.
Can I still qualify? Yes, so long as the investor contacts the Qualified Intermediary to set up the Reverse Exchange in advance of the purchase escrow closing escrow.
What happens if I don’t locate a property in the allotted amount of time? The Qualified Intermediary would release funds on day 46 and the investor would be subject to the same capital gains tax had the investor not completed a 1031 exchange.
The Exchange Period starts the day after escrow closes on the sale property. The IRS allows 180 calendar days to close escrow on the purchase property(s) that the investor identified within the first 45 calendar days of the 180 calendar day exchange period. The investor should always discuss timeline requirements, identification rules directly with the 1031 Qualified Intermediary.
As a Certified Exchange Specialist®, what are the latest market trends you’ve seen? The main trend we see is that investors are having a hard time locating replacement property, they are looking out of state and looking at other types of investments including single tenant and triple net properties and Delaware Statutory Trusts that may available.
Every investor is unique and every investor has different goals depending on if they are an individual, family, business investor or a large corporation, developer and/or institutional REIT. The rules and requirements under IRS Code Section 1031 are the same for all investors. The Qualified Intermediary industry continues to be an unregulated industry so therefore you need to make sure that you take time to do your research and understand how the investor proceeds are held.
Teresa Moss Fluegel
Teresa Moss Fluegel, Executive Vice President (San Francisco) joined CDEC in 2000 and is responsible for providing consulting services to real estate and tax attorneys, accountants, investors and commercial real estate professionals on the West Coast. She is a frequent lecturer on IRC Section 1031 and has presented accredited courses to real estate and tax professionals. Ms. Fluegel brings over 25 years of professional experience and expertise to the field. Teresa has participated in several panel discussions including at the California Real Property Retreat and at UC Berkeley. Additionally, Teresa is a co-founder of the monthly Real Estate Advice Seminar Series provided to commercial real estate professionals, investors and advisors in the San Francisco Bay Area. Prior to joining CDEC Teresa spent ten years working for a national title insurance company.
Teresa holds the Certified Exchange Specialist® designation and is actively involved in a number of professional organizations including San Francisco Commercial Real Estate Women (SFCREW), CREW East Bay, Northern California Chapter of CCIM, Society of Industrial/Office Realtors and Commercial Women in Real Estate. In 2013 Teresa was awarded Most Valuable Member by CREW East Bay. In 2016 Teresa earned the CREW Network Certificate in Leadership in recognition of her successful program completion. Teresa was nominated by her peers in 2016 for the Inspirator Award at the Annual Elevate Awards, an event honoring diversity and women’s leadership in commercial real estate. Teresa currently serves as President of CREW East Bay.
Contact Teresa at: (415) 596-6749 or Teresa.Fluegel@cdec1031.com