More people are using this option to defer taxes on such investments.
The strong real estate market in many areas of the country may be one reason that interest seems to be growing in 1031 exchanges, a technique used to defer capital gains taxes on the sale of appreciated investment or business property.
Also contributing to the trend, observers say, are landlords in their fifties and sixties who want to defer capital gains and stay invested in real estate, but reduce their activity. Some are scaling down from larger buildings to smaller ones, while others are choosing sponsored "Tenancy In Common" arrangements, which allow them to be one of many passive investors in a commercial property. (See sidebar.)
Others say it's just an increased awareness that Section 1031 of the Internal Revenue Code allows such deferrals. But to get the benefit, investors must comply with a specific set of rules. Among the most important requirements are that after the sale, a like-kind replacement property must be identified within 45 days (up to three possibilities can be identified) and closed upon within 180 days. A qualified intermediary must hold the proceeds from the sale until the other property is purchased.
Although advisors and others report rising interest in 1031 exchanges involving real estate, no one has an accurate number on exactly how many of them are being done. The IRS, which requires Form 8824 to be filed for like-kind exchanges, does not have recent numbers on how many such forms were filed. Its latest figures show 108,537 forms filed in 2000 by individual taxpayers, and 45,078 filed in 1997 by corporations.
And these numbers include more than real estate transactions. The IRS permits like-kind exchanges of many types of business property-airplanes, livestock, computer equipment and even copyrights, for example, may qualify under Section 1031. But exchanges of stocks, bonds, notes, partnership interests and other securities don't qualify.
Tim Egan, executive director of the Federation of Exchange Accommodators (FEA), a business organization representing qualified intermediaries, says that although the number of 1031 exchanges is unknown, the FEA believes they are rising because member companies are reporting increased activity. The FEA has almost 300 members and represents 85% of known, full-time qualified intermediaries in the United States.
"We've gotten general input that leads us to the strong and accurate conclusion that most 1031 transactions are done basically by individual taxpayers, a husband and wife who have a modest duplex and want to trade into something of similar value," Egan says.
Advisor John LeBlanc, co-founder of Back Bay Financial Group in Boston, has had many client couples consider 1031 exchanges, and he believes the strong real estate market in the area has helped fuel their interest. "In the Back Bay and South End of Boston near my office, I've had clients who bought brownstones for $100,000 twenty years ago and now they're going for $1.2 million to $1.5 million. It's like Park Slope in Brooklyn. The area got better and more desirable," he says.
George Middleton, an investment advisor with Limoges Investment Management in Vancouver, Wash., helped a client do a 1031 exchange with an office building. "He got an offer on his building in Seattle, and it was kind of an offer he couldn't refuse," he says. The property was close to King County International Airport/Boeing Field and an interchange off Interstate 5, which made the property extremely valuable, he explains.
"He sold the building for about $850,000, and his basis was down to about $160,000, since he'd depreciated it. So he had an almost $700,000 gain that he would have had to pay taxes on," Middleton recalls. Using a 1031 exchange, the client replaced the Seattle building with one in Sacramento and one in Vancouver, he says.