Need to up your real estate tax savings game? Insider tips on 1031 exchanges in today’s market.
Updated: Aug 30, 2019
Article Written by Corinne Iadonisi, Jesse Limon, & Chris Young
If you’re in commercial real estate, chances are, you’ve heard of the illustrious 1031 exchange, to save you on capital gains taxes. In a typical 1031 exchange, the seller of the relinquished property has 45 days to identify potential replacement assets with a total of 180 days from closing date to acquire the new deal. For some investors, this is a stressful process and if the market is hot, like it is right now, it might be tough to find the deal for you.
Investors can easily unload their property in today’s market, but identifying a replacement property within 45 days that has a decent CAP rate can sometimes be challenging and for some investors the added pressure does not make sense. We are seeing a trend in exchanges – the simple forward exchanges can fail if you do not find the right replacement, and some savvy investors are turning to reverse 1031 exchanges.
If a 1031 is the white horse, most think of the reverse 1031 exchange as the dragon. But no longer can you keep up with the competition unless you understand how to use this potentially valuable tool in your business.
The reverse exchange allows you to purchase your replacement property first. The upside? You have UNLIMITED time to find the right investment property as a buyer. No longer do you have to worry about doing due diligence or putting together the contract in a frenzy while running down the IRS imposed clock. Take all the time you need to set up your next move.
Once you find your star property and have a Purchase and Sale Agreement in place, contact a qualified intermediary to help with the transaction.
Caution: not all 1031 companies handle reverse exchanges, and some handle better than others. Look for a company that has attorneys on staff – this will help you iron out the legal implications of the transaction with your lenders.Which leads to the downside. Talk to your lenders first if you will end up with a loan on the replacement property. Some lenders see it as too much risk, or don’t understand the terms in play. In the worst case scenario that you purchase the replacement property AND your relinquished property does not sell, you could be on the hook for both loan payments. If you are willing to take on this amount of risk, then move past GO and collect $200. (That’s a Monopoly reference for you Millennial's out there...)
Working with predominantly 1031 exchange type properties and with 1031 buyers and sellers, the following are five general strategies to consider:
Focus on Management Free Deals like Single-Tenant, NNN with Longer Term Leases . Management-free NNNs provide longer-term leases and less overall headache and it typically makes sense to go with corporate guaranty from reputable tenant. This type of asset frees up the investor and they can deploy time in other directions, justifying a possibly lower return than in the apartments they own.
Recession proof is best. Dollar General could be considered the best in this category right now, another very good option is auto parts stores like Auto Zone, Advance Auto, or O’Reilly Auto Parts.
Try not to get stuck for longer term holds, with flat leases, buy deals that give increases in base years.
Location is everything. Every piece of real estate is different, do your homework on the site from the local economy, to the demographics, to the sales trends at the locations, etc.
Bank finance-ability. Even if you don’t have a debt portion to your 1031, getting quotes from lenders usually costs nothing and will at least give you an idea of the safety of the tenant as the current retail environment is in flux, not all corporate guarantees are created equal.
To implement your own 1031 strategy or to find out more about the market, contact someone from our national commercial real estate deal team:
Jesse Limon, Marcus & Millichap Manhattan Office, Investment Sales; Jesse.Limon@marcusmillichap.com
Corinne Iadonisi, Global Partners Exchange, Managing Director; CIadonisi@gpx1031.com
Chris Young, Thomas Title & Escrow, Director of Business Development; CYoung@thomastitle.com