In my family, Thanksgiving dinner is one of the most anticipated holiday dinners of the year. The family, the football, and especially the food cannot be matched! However, the next greatest thing to come out of Thanksgiving dinner is the LEFTOVERS! You have not lived until you’ve had leftover pumpkin pie and a turkey cranberry sandwich for breakfast on the morning of Black Friday. Undoubtedly, the leftovers of Thanksgiving dinner can bless your life with delicious holiday foods and flavors for days to come.
Likewise, in the real estate world “leftovers” are something to look forward to, and can bring great value to you in the form of passive income. Making sure you know what to do with your real estate “leftovers” all begins with knowledge about 1031 exchanges.
What is a 1031 Exchange?
A 1031 exchange is a powerful tax deferral tool and strategy. Doing a 1031 exchange enables the landlord of an investment property to sell the rental property and purchase a replacement property, all while deferring taxes. Landlords take advantage of the 1031 Exchange to upgrade their real estate portfolio, “retire” into something more passive and aligned with their lifestyle, and diversify into something less risky.
A common misconception is that a 1031 exchange must be deed-for-deed (meaning the exchange must happen at the same time with the same people). The IRS has clarified that as long as the exchange happens within a certain time frame and with a “qualified intermediary”, also known as an exchange accommodator, it qualifies as a 1031 exchange. The time frames given are 45 days after closing on the relinquished property to identify a replacement property, and 180 days from closing to close on the replacement property. The qualified intermediary is a person or company who is not otherwise involved in the transaction, but facilitates the transaction, meaning they make sure everything is within IRS guidelines and safe harbor, prepares the necessary paperwork for the exchange, receives and holds the funds from the sale of the relinquished property, and sends funds to complete the purchase of the replacement property.
Real Estate Leftovers (IE “Boot”)
Another common misconception is that in a 1031 exchange, the full exchangeable amount from the sale of the relinquished property must be used to purchase a replacement property. This is true if the taxpayer is looking to defer all taxes related to the sale. However, if the landlord has leftover 1031 exchange funds not used in the purchase of a replacement property, either by choice or circumstance, the funds are referred to as boot. For example, if a person sells 4 residential rental houses for $500,000 each and does a 1031 exchange into a commercial real estate building worth $1,700,000, they would have $300,000 leftover “boot”.
Using a 1031 Exchange to Season your Leftovers
The question is what do you do with the boot? They could take that $300,000 as cash after the exchange and pay taxes on it (typically around 30% – ALWAYS check with your CPA). This would net about $210,000 to the landlord. But if they don’t want to take it out as cash and have that taxable event, they could place the $300,000 into a real estate investment, which would qualify for a 1031 exchange. Millcreek Commercial’s fully managed, triple net leased commercial real estate TIC properties are the perfect solution for this boot. An investor, for example, can purchase a portion of a commercial real estate investment property with a long-term lease (stability), that has a corporate guarantee (security), and a NNN lease (safety). An investment of this size, paying a 5.50% CAP rate, would yield $1,375 per month, as long as the tenant is paying rent.
Do you know someone who is doing a 1031 exchange? Let them know that we can help. We specialize in providing replacement properties suited for 1031 exchanges. These are safe, secure, and stable commercial real estate properties with long-term net leases. We are a great solution for boot. Reach out to us by phone at (385) 248-0613 or email at email@example.com.