1031 Exchange Investment Property Sales

Do you own a property in Greater Boston? Are you considering a 1031 exchange so you can improve your financial outlook? Then check out my videos below for more information on why conducting a 1031 exchange to get into the Cambridge, Somerville or Medford MA real estate markets could be a game changer for you.

The 1031 exchange allows you, the seller, to upgrade to a better property (or properties) situation without paying a single dollar in taxes. A better property often means a better location, better profits, less stress, less time involved in the investment, and/or more day-to-day convenience.

All this being said, surprisingly very few landlords in Greater Boston know about the power of the 1031 exchange. And even fewer landlords actually make use of the 1031 exchange.

That’s where I come in.

If you are hoping to sell your investment property so you can purchase a new (and hopefully better) investment property, you will need someone who truly understands the 1031 exchange process.

Let’s begin with some of the basics below:

What is a 1031 Exchange?

A 1031 exchange is a reference to a portion of IRS tax code that allows a seller to take 100% of their property’s gain and use it to buy a new property. As long as the 1031 exchange is properly executed according to the IRS, the seller will not have to pay any capital gains or depreciation recapture taxes on the sale. Instead all gains and depreciation recapture taxes are deferred.

Why should I consider a 1031 exchange?

I think 1031 exchanges are one of the least utilized approaches in the areas I work in  and I don’t understand why. I regularly see property owners who have investment properties (both multi-families and condos) that are less than ideal due to a poor location, poor layout, homeowner association issues, looming & expensive capital expenditures, time and stress involved, and countless other factors. 

Instead of continuing to get less than ideal returns on their investment, the right thing to do would be to sell and 1031 exchange into a much better investment property scenario. 

You might ask: why not just sell your investment and keep the profits and not bother with this annoying exchange process?

Firstly, all of your gains will be taxed. And in the multi-family world of Greater Boston, it’s not uncommon to see gains of $100k, $200k and even $1M+ on one property sale alone. That tallies up to a really high capital gains tax. Often times I’ve seen effective capital gains rates of 25% (factoring in federal and local capital gains rates). On a $1M sale, a 25% effective tax rate is equal to $250,000 in taxes paid!! Of course, ALWAYS consult with an accountant before making ANY tax decisions and to be clear, I am NOT an accountant or providing any tax advice in this article.

But there’s a second tax burden that many owners miss and that is depreciation recapture. When you own investment property, the property value (minus land value) is divided by 27.5 years. That amount is then deducted from your rental income each year as depreciation.  For example, let’s say the value of your 2-family, not including the land, is $500,000. Each year, you can write off a portion of the property as depreciation. In this example, it would be $18,181/yr.

But when you sell, the IRS wants some of that back. But if you go the 1031 exchange route, that amount is actually deferred, meaning you don’t pay the tax on the depreciation recapture either.

This is all to say -  if you have an investment property and you are unhappy with your returns or you are unsure if you can or should be getting better returns, REACH OUT to me and I will give you my honest assessment. Some properties are buy and hold forever. For example, if you have an investment that is performing well and you have no serious issues, there's a good chance it's best to just hold for the long term.

If I decide to conduct a 1031 exchange, how many days do I have to identify and buy a new property after my existing property is sold?

Once your existing property closes, you have 45 days to identify a new property. Once your existing property closes, you have 180 days to close on a new property. 

Can I only sell one property? Can I only buy one property?

You can sell one or multiple properties. You can also buy one or multiple properties in a 1031 exchange.

What are the tax implications?

Always consult with a CPA to understand your unique circumstances. As long as the property you are buying is equal or greater in value to the property you are selling AND as long as the property you are buying has equal or greater debt than the property you are selling, you should pay nothing in capital gains or depreciation recapture - those costs will be deferred. 

Can I sell my primary property in a 1031 exchange?

No, you cannot sell your primary property in a 1031 Exchange. You can sell investment properties only. 

Are there rules about what kind of properties can be sold in a 1031 exchange?

You can do any kind of commercial or residential property you could think of, as well as land, as long as the property being sold is not your primary home. This includes single families, condos, multi-families, warehouses, industrial buildings, mix-use buildings, retail, etc. 

Can I buy a primary property in a 1031 exchange?

You can only buy an investment property through a 1031 exchange.

Can this new investment property ever turn into my primary home?

A lot of clients come to me and ask if they can use the 1031 exchange process to obtain their dream or retirement home. If you’d eventually like to turn your new investment property into a primary home or vacation property, you’ll need to do a couple things:

1. After closing, you’ll need to keep the property as an investment property for at least 2 years.

2. For each of those two years, you should rent the property out at fair market value and not use it personally for more than 14 days or 10% of the total days it is rented (whichever is greater).

I recommend an initial call with me (617-833-7457) to discuss your unique circumstances and ultimately you should rely on your CPAs recommendations here.

What are the costs to conduct a 1031 exchange?

You will need to hire what's called a "qualified intermediary" to run your 1031 exchange - real estate agents or attorneys or your accountant cannot do this for you. This QI can give you a quote on your costs or reach out to me personally and I connect you to a professional QI.

Do I need to sell my existing property first? I don't like the idea of having only 45 days to find a new property.

There is also a reverse exchange, which allows you to buy before selling your investment property, but that typically requires a very strong financial situation where you can fund the purchase on your own prior to the sale of your existing property or properties. I also have a number of strategies I employ to help conduct 1031 exchanges successfully to extend the decision making timeline. Contact me to discuss 617-833-7457.

Are there geographic limitations on where I can do a 1031 exchange?

You can do a 1031 exchange anywhere in the United States. That means the property you're selling doesn't need to be in Cambridge, Somerville or Medford, it can be anywhere in the US! And of course, when you buy a new property or properties it must be in the US as well. Often times, I have clients selling their investment properties in Cambridge, Somerville and Medford and they utilize a 1031 exchange to purchase new investment properties in states where they are retiring too. Definitely a great option for many clients ready to move on from the Greater Boston area!

What are some real life examples of how I’ve helped clients achieve a 1031 exchange?

If you are considering a 1031 exchange in Greater Boston, you need to work with someone who has considerable expertise helping landlords do this at the local level. Below are just a couple of case studies on how I’ve recently helped landlords carry out 1031 exchanges.

1031 Case Study: Trading Up from Watertown to Cambridge

And finally - I wrote an entire guide on the 1031 Exchange Process. Just email me at Sage@CambridgeSage.com or text/call me at 617-833-7457 and I’ll give it to you for free.

Also, if you sign-up for my FREE monthly Sage Report newsletter, I’ll provide you with regular updates on the local real estate market and more 1031 exchange advice and case studies.

What you really need to understand about the 1031 process is it is TOTALLY doable, but it does require some planning, great time management and some expert local real estate advice. If you want to discuss further, please give me a call anytime at 617-833-7457, or send me an email at sage@cambridgesage.com.

Glossary of Common Terms Related to 1031 Exchanges

Depreciation recapture: When you own an investment property, the property itself (not the land), is depreciated as a write-off over a period of multiple years. This results in a tax write-off each year against rental revenue. But when you sell, the IRS wants some of that write-off back in the form of "depreciation recapture" tax. But if you conduct a 1031 exchange, you can defer this tax either partially or completely.

Capital gains tax: Every dollar you sell above your original purchase price is a capital gain. There is short term and long term capital gains tax. For investment properties in MA, you have federal AND MA capital gains taxes considerations. 

Cost Basis: This refers to the original value of your property. Honestly, this one can get complicated so I recommend you utilize a CPA to determine your true cost basis.

Qualified Intermediary: When executing a 1031 exchange you need to hire a QI. It cannot be your real estate agent, attorney or accountant. Ping me and I can give you a great rec.

Reverse Exchange: For those that have heard of 1031 exchanges, the most typical is a forward exchange, where you sell your existing property, then have 45 days to identify a new property and 180 days to close on your new property. There is also a reverse exchange, where you can buy the new property before selling your current property. To do this, you typically need to be in a very strong financial situation where you can afford to finance the purchase prior to selling your existing property.

Delaware Statutory Trust: This is form of a 1031 exchange where you take the proceeds from the sale of your existing property and put them into a new property without the burden of active management. This could be a good option for someone looking to become a purely passive investors OR for investors who are on a tight timeline during their 1031 exchange.

Step Up Basis: If you own real estate investment property and die, your heirs will inherit the property on a stepped up basis. This means for your heirs, all previously deferred depreciation recapture and capital gains will be "stepped up" at the time of your death. Ultimately, this means your heirs get to AVOID all the capital gains and deprecation recapture you would have paid, should you have decided to sell your investment properties prior to dying. Morbid I know, but this right here is arguably the easiest and best way to generate generational wealth for your family!