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The 1031 exchange is an ideal way for investors to reduce their tax burden and continue to grow their investment portfolio in both the short and long term. As a result, many clients come to Legacy Commercial Group either ready to make this exchange or are interested in using the strategy to lessen their tax burden later on. However, 1031 exchanges are not always the best solution for investors on a case-by-case basis, even if they initially believe it is. 

A 1031 exchange allows investors to defer capital gains taxes by reinvesting the proceeds into a “like-kind” investment vehicle. Whether that be another commercial property, a DST, or another qualifying asset, this tax strategy can help keep capital working for investors and help them escalate their portfolio by increasing cash flow with the exchange of each new property. 

While this strategy can help you in many cases, it is not the end-all-be-all for commercial real estate investors. Before entering into a 1031 exchange, ask your advisor (and yourself) these questions: 

Is the tax liability worth avoiding? 

When we talk to many clients for the first time about a possible 1031 exchange, many have yet to speak with their tax advisor about their tax burden for selling a particular property. This is critical information to have to determine whether a 1031 exchange is a “want” or a “need” in determining your next steps. 

Do I need the cash now? 

Partial 1031 exchanges allow the investor to reinvest some of the equity from a property sale while cashing out a portion of the non-exchanged amount. This is often a route investors will take if they need cash for unexpected life events, but in many cases, this defeats the purpose of the 1031 exchange. In addition, the tax benefits may not be worthwhile if cash is a priority for things like medical bills, retirement, or other incentives. 

Can I utilize other tax losses to offset capital gains?    

Investors may be able to offset capital gains if they can claim net operating losses (NOL) or passive activity losses (PAL) from other properties within the portfolio. This restructuring can help reduce the overall tax burden, making a 1031 exchange unnecessary and using losses to their advantage. 

Is this a wise investment strategy, not just a wise tax strategy? 

At Legacy Commercial Group, we always tell clients to look at their investment strategy first and worry about their tax strategy second. While a 1031 exchange may look like a good idea from your tax advisor’s perspective, the deferred gains will not pay off in the long run if the new opportunity is not a good option for your portfolio.  

Legacy Commercial Group specializes in 1031 commercial property exchanges and can help you maximize your portfolio for short- and long-term benefits. To learn more about your 1031 exchange options, contact us today!