Why I don’t love 1031 exchanges

|

We’ve talked a bit about 1031 exchanges before, but here’s a re-cap:

  • 1031 is a tax loophole designed to allow a seller to avoid paying capital gains tax on a property when he sells
  • To do so, seller sells his property and has escrow transfer his equity to a so-called 1031 facilitator
  • Then, seller has a set time period to identify several properties he might buy with the equity
  • He makes an agreement to buy one
  • At closing, the equity comes in from the facilitator
  • The original seller avoids paying capital gains tax on any profits in the deal; instead, he transfers his old tax basis to the new property

There are a bunch of rules and regulations I’ve left out of the above description for the sake of simplicity.

But, if you’re sharp, you can already spot the problem with being a 1031 exchanger. Can you spot it?

The problem is with the “set time period”. Any time you are up against a hard deadline in a negotiation, you’re at the mercy of the other party.

In this case, the problem is that the owner of the property you’re trying to exchange into knows that you are on a deadline. If he wants to play hardball, he can delay until you are up against the clock and then push you for concessions, knowing that you have to accept them or risk having to pay capital gains tax on your sale.

The net result of the above is that a 1031 exchanger is at a significant disadvantage. Sure, there are plenty of times when the tax savings are large enough that it doesn’t really matter if you aren’t getting a great deal. But, if the savings are marginal, my advice is to forget the exchange, pay the tax, and focus on getting yourself a good deal.

Share