A 1031 deferred exchange is the sale of one investment for the purchase of another investment. In terms of NNN property and/or mortgage, when an NNN property investor sells one NNN investment property to buy another, like property, they can offset or even avoid capital gains tax. In a 1031 property exchange, the NNN property sold is referred to as the “relinquished property” and the triple net property acquired is called the “replacement property”.
- The properties exchanged must be of like-kind, meaning that they are of the same classification, and not based on their condition or quality. However, this category is broad, and can mean selling a farm to buy raw land. Or, selling an office building and buying a strip center.
- Real estate is divided into four classifications, including property held for business use, land held for investment, property held for personal use, and NNN property held primarily for sale. The first two qualify for a 1031 deferred exchange, while the last two do not.
- The exchange must occur in the allotted time frames. There are strict timelines for a 1031 property exchange to work including an identification period of 45 days during which you must identify a replacement property after selling your old one. Also, heed the exchange period of 180 days – this spans from the date you sell your old property until you must close on the replacement property
- There must be an actual exchange overseen by a qualified intermediary or QI, and not just a transfer of NNN property for cash. That being said, it’s always wise to seek the services of a professional early on to avoid any costly mistakes when executing a 1031 deferred property exchange.
- Contrary to popular belief, a 1031 deferred property exchange isn’t an all-or-nothing situation. You can do a partial exchange. However, if you buy a property for a lower sale price than your original property sold for, some of the original property’s sale price is taxable. The same is true if you choose to take on less debt with the replacement property. Let’s say you sell a NNN investment property for $1,000,000 when you have a $250,000 mortgage. You buy a property for $500,000, also with a $250,000 mortgage. The $500,000 you receive during the transaction is taxable income. In other words, you still defer tax on the bulk of the sale of the first property. But you’ll pay capital gains tax or depreciation recapture on the money that didn’t get rolled into the new property.
For the savvy NNN property investor, a 1031 deferred exchange can defer taxes and generate more cash flow and appreciation potential. Part of the equation for higher cash flow is to structure the best possible mortgage loan. By planning ahead, exchangers will obtain their investment goals with the flexible mortgage products available in the market place. Plan your next 1031 NNN Property exchange with lending issues in mind!
Remember, the purchase price of the property (or properties) you buy must equal or exceed the sale price of the property or properties that you sell. So if you sell a property for $500,000, you’ll need to buy another property for at least that amount in net equity. Net equity on a settlement statement NNN property for cash (or cash due seller) results from the gross selling price minus retired or paid off debt, selling expenses, sales commissions and closing costs. Also, there’s a debt financing requirement that applies if you have a mortgage on your original triple net NNN property. In a nutshell, you’re required to carry as much debt or more with your replacement property.
Call or Email your favorite NNN property advisors at The Triple Net Investment Group for the best insight into your 1031 deferred property Exchange.
