One way to avoid a large tax bill on the sale of a commercial property with a big capital gain is to utilize a 1031 exchange.
If you have owned your Southern California commercial property for a while, you’re likely to have a capital gain. One of the popular ways to defer having to pay taxes on this gain is utilizing a 1031 exchange. A 1031 exchange requires that you buy a “like-kind” replacement property of equal or greater value. There is some confusion surrounding what “like kind” means, but it generally it means you can trade commercial property for residential or vice versa. One of the popular trades many investors are weighing regionally is trading out of multifamily and into industrial due to concerns over rent control and other potential changes.
Using a delayed exchange (most popular) after close of escrow the seller has up to 45 days to identify three potential replacement properties and 180 days to complete the purchase of a replacement property. To facilitate this process, you need to utilize the services of a Qualified Intermediary, that we sometimes call an Accommodator. A good broker can refer an accommodator and can help with finding and purchasing the property to trade into.
You will also want to investigate what types of properties to trade into. A Net Leased Investment like a Starbucks or McDonalds can offer passive returns with little or no work on your end. Or if you are willing to do more work, you could choose to invest in a Value-Added Investment where you see upside potential. A good broker can help you with finding these investments and planning for what fits your situation best.
In review one way to avoid a large tax bill on the sale of property with a big capital gain is to utilize a 1031 exchange. This allows you to defer your capital gain by trading into a “like-kind” property. The types of property to trade into should also be given some thought as well depending on how actively you want to manage/be involved with the new property.
Ron Mgrublian is a Commercial Real Estate Broker focusing on Industrial Real Estate and Warehouse Properties with the Lee & Associates Los Angeles – Long Beach, Southern California office.