Florida Expert Explains the 1031 Exchange

One of the most common real estate transactions locally is the 1031 exchange, yet it is also a mystery to most buyers and sellers. It doesn’t have to be. Real estate tax specialist Dick Goble, a senior partner with the accounting firm Kerkering, Barberio & Co., specializes in these transactions and advises clients on them nationally. He recently sat down with the Sarasota Herald-Tribune to discuss the benefits of 1031 exchanges to real estate buyers and investors.

~~~~~~~~~~~~~~~~~~~~~~

HERALD-TRIBUNE: What is a 1031 exchange?

GOBLE: A 1031 exchange is also sometimes called a like-kind exchange, and it refers to the sale of property used in a trade or business, or one that is held as an investment, in exchange for property that is used in a trade or business, or one held for investment.

HERALD-TRIBUNE: How do they work?

GOBLE: The basic 1031 exchange happens when someone sells a parcel of real estate, and deposits funds with an independent third party known as an intermediary. From there, they have within 45 days have to identify a replacement property — the like-kind property — and 180 days to close on that property.

HERALD-TRIBUNE: How prevalent are 1031 exchanges to the Southwest Florida housing market?

GOBLE: At a seminar on 1031 exchanges in San Diego, one of the national exchange services was there, a company that functions as a qualified intermediary nationally. Attendees were told that South Florida and Southern California are the two most active spots in the country for 1031s due to the rapid increase in the value of real estate here.

HERALD-TRIBUNE: What does that have to do with an increase in the number of 1031 exchanges?

GOBLE: 1031 exchanges provide buyers the ability to defer all income tax on the sale of property if they buy a new property of equal or greater value. For instance, if someone buys a parcel of Southwest Florida real estate for $100,000 and sells it for $1 million, they would be looking at $900,000 in taxable capital gains. If, then, they were to do purchase another property for $1 million using the 1031, they would pay no capital gains tax on their sale.

It’s important to note, though that it’s a deferral of the tax, not a permanent way around it. Using the above example, the basis for the tax would be $100,000. The only way that gain ever goes away is if the asset is included in an estate when someone dies, or if the property is given away as part of a charitable donation.

HERALD-TRIBUNE: Who benefits primarily from a 1031 exchange?

GOBLE: Mostly individuals, but benefits can be derived by any entity that invests in real estate: partnerships, corporations and REITs.

HERALD-TRIBUNE: Are there any disadvantages to 1031 exchanges?

GOBLE: You don’t get the step up in depreciation to the value of the replacement property. In our $1 million purchase example, the $100,000 number was used to compute depreciation. Although the property in question sold for $1 million, you’d still have $100,000 as the basis for depreciation.

If you did not opt for a 1031, you’d have bought a replacement property for $1 million and you’d have $1 million as the basis, but you’d also then have 10 times the depreciation each year, which shelters the income that would be otherwise be produced by the property. In an exchange, $100,000 becomes your basis for depreciation, not $1 million.

There are also additional costs associated with doing a 1031 exchange, such as the cost of the intermediary. Nationally, many charge between $400 and $500. In Southwest Florida, the charge is generally $750 to $1,000 for a single property exchange.

HERALD-TRIBUNE: Do you expect 1031 exchanges to become more prevalent in this market?

GOBLE: Not necessarily, as we already have an extremely active 1031 market here, but I don’t see the frequency of exchanges diminishing at all. It’ll continue to be very active. Moreover, it’s still a foreign concept to some people, though it is starting to become more and more popular nationwide.

~~~~~~~~~~~~~~~~~~~~~~

As that occurs, the 1031 option will remain a popular choice with Southwest Florida home loan applicants as well.