Section 1031 of the Internal Revenue Code (IRC) allows an owner, who holds property for “productive use in a trade or business or for an investment”, to defer payment of taxes on capital gains. capital if the owner sells that property, identifies a “like kind” property within forty-five days of the sale, and acquires a “like” property within one hundred and eighty days of the sale.
The coronavirus pandemic has made 2021 a very difficult and chaotic year with many starts and stops in the economy as a whole. While the uncertainty of the pandemic continues to have a negative effect on certain segments of the economy, it appears to have accelerated the real estate market locally and nationally. We experienced a significant increase in volume of 1031 trades in 2021, and we expect this to continue in 2022.
A few factors that will contribute to the continued maintenance and growth of 1031 exchanges are (i) the likelihood that financing rates will remain low (ii) homeowners facing significant capital gains taxes when sale due to real estate market appreciation, (iii) repurposing of real estate due to changes in certain segments of the real estate market, (iv) sale of investment properties in colder climates and purchase of replacement buildings in warmer climates or in areas of the country generally referred to as vacation zones, (v) the availability of reverse exchanges and building improvements, and (vi) retirement and estate planning for baby -boomers.
The pandemic has pushed many workers to work remotely with great success using advanced virtual technology, which has caused a backlog in the commercial office and retail sector. As such, many of these office and retail spaces may need to be redeveloped.
These properties can be ideal targets for investors looking to make a construction or improvement exchange which are discussed in more detail below. In addition, like-for-like Section 1031 swaps incentivize investors who cannot afford building improvements to sell properties to investors who have the capital to make such property improvements.
Despite the negative impacts that COVID-19 has caused on parts of the real estate sector, particularly in the retail and office markets, the increase in property values throughout New England and particularly in the Massachusetts gave investors large shares in their properties, subjecting them to higher capital. tax gains on the sale of these properties. Therefore, more and more investors are using 1031 tax-deferred exchanges to defer paying capital gains tax. Investors participate in exchanges for a number of different reasons. They may want to diversify (sell one large property and buy multiple smaller properties), consolidate (sell multiple smaller properties for one larger property), or buy another investment property that has a better income stream, is easier to manage, or has more more benefits than the property they currently own.
However, the limited supply of replacement investment goods has increased so-called “reverse trades” and “build/improvement trades”. A reverse exchange occurs when an investor first buys the replacement property and then later sells their abandoned property. Due to the limited supply of investment properties available, investors do not want to sell their property and be left with nothing to buy. Reverse exchanges can be a useful tool to ensure the successful purchase of a replacement property before giving up one’s current investment property. A build/improvement swap occurs when an investor constructs a building on vacant land as part of replacement ownership or makes improvements to an existing building. This allows investors greater flexibility to complete an exchange by having the ability to consider a wider range of price ranges for replacement properties, and if structured correctly will have a positive tax deferring outcome. on capital gains.
Locally, Greater Boston is home to some of the best financial institutions, universities, hospitals and technology companies in the world, which will continue to drive demand for rental properties. Although a slowdown or price corrections are inevitable, especially in certain segments of the real estate industry, there is still plenty of evidence that the real estate market remains strong in the Greater Boston area.
Brendan Greene is Owner/Operator/Lawyer and Mark McCue is Owner/Operator/Lawyer at Greater Boston Exchange Company, LLC (a subsidiary of McCue, Lee & Greene, LLP), Boston, Mass.
