1031 Exchange Basics for Utah Commercial Property Owners

Sell a commercial building you have owned for years, and the tax on the gain can take a real bite out of what you keep. A Section 1031 like-kind exchange lets you defer that gain, not erase it, by trading into other qualifying real estate. The rules are strict, and a small mistake can make the whole gain taxable.

This is general education, not tax or legal advice. Plan any exchange with your CPA or tax attorney, and run it through a qualified intermediary, before you sign a contract to sell.

What a 1031 exchange does

The IRS like-kind exchange tax tips page states the core rule. Exchange business or investment real property solely for like-kind business or investment property, and you generally do not recognize gain or loss. If you also receive money or other property, you recognize gain up to that amount.

The deferral works through basis. Per IRS Publication 544, your basis in the property you receive is generally the same as your basis in the property you gave up, with adjustments. The untaxed gain carries into the new building.

What qualifies after 2017

The Tax Cuts and Jobs Act narrowed Section 1031. Since January 1, 2018, it applies only to real property, as the IRS explained in news release IR-2018-227. Exchanges of machinery, equipment, vehicles, artwork, collectibles, patents and other intangible business assets generally no longer qualify.

For real estate, "like-kind" is broad. Properties are of like kind if they share the same nature or character, even if they differ in grade or quality, and improved real property is generally like-kind to unimproved real property. So a Utah owner could generally exchange a retail strip for an industrial building, or an office building for land, if both are held for business or investment.

Limits worth knowing:

• Use matters. Both properties must be held for use in a business or for investment. Real estate held mainly to resell, such as a developer's inventory of lots, does not qualify.
• U.S. for U.S. only. Real property in the United States is not like-kind to real property outside the United States.
• Partnership interests are not real property. The Form 8824 instructions list interests in a partnership (with a narrow election exception), stock, bonds and notes as never real property for Section 1031. If your building sits in an LLC with several owners, ask your CPA early who is exchanging.
• Related parties. Exchanges with family members or related entities have special rules, including one that can trigger the deferred gain if either side disposes of the property within two years.

The 45-day and 180-day deadlines

Most exchanges are deferred: you sell first and buy later. Per the Form 8824 instructions, the replacement property must be:

1. Identified within 45 days after you transfer the property you give up. It must be in writing, signed, describe the property clearly (legal description, street address or a distinguishable name) and go to a proper party to the exchange.
2. Received within 180 days, or by the due date of your tax return (including extensions) for the year you transferred the property you gave up, whichever is earlier.

That last clause is easy to miss. Close late in the year, and your return could be due before day 180. Ask your CPA about an extension.

Publication 544 also limits how many properties you can identify. Generally, you can identify up to three properties of any value, or any number of properties whose total fair market value is not more than double the value of the property you gave up. Going past those limits can spoil the identification, with narrow exceptions, such as receiving at least 95% of the total value you identified.

Plan as if these deadlines will not move, and have candidate replacement properties in mind before you close.

The qualified intermediary

The cash is the trap. Publication 544 explains that if you actually or constructively receive the money before you get the replacement property, the deal is treated as a sale, not an exchange. A qualified intermediary (QI) solves this. Under a written exchange agreement, the QI handles the property you give up, holds the proceeds and acquires the replacement property for you, and the agreement must expressly limit your rights to that money.

A "disqualified person" can't be your QI. That includes related parties and anyone who has acted as your employee, attorney, accountant or real estate agent or broker within the two years before the transfer, with exceptions for routine exchange, title and escrow services. Your real estate broker can't hold your exchange money.

Choose the QI with care. Publication 544 notes that if a QI can't meet its obligations or causes you to miss a deadline, your exchange may not qualify and the gain may be taxable in the current year. Ask how the funds are held and protected.

Boot and debt

"Boot" is the common name for anything you receive that isn't like-kind property: cash, a note or other property. Boot is taxable up to the amount of your gain.

Debt counts too. Per Publication 544, if the other party takes on your liabilities, you are treated as receiving money in that amount, reduced by any liabilities you take on, cash you pay and non-like-kind property you give up. That is why many exchanges aim to buy property of equal or greater value and replace paid-off debt with new debt or added cash. Run your numbers with your CPA.

Example: These numbers are hypothetical and simplified, ignoring closing costs and depreciation recapture. An owner with no loan and an adjusted basis of $600,000 sells a building through a QI for $1,500,000, a $900,000 gain. She buys a replacement building for $1,400,000, and the QI returns the leftover $100,000 to her. That $100,000 is boot. Here, $100,000 of the gain is taxable now and the other $800,000 is deferred.

Reverse exchanges, at a high level

Sometimes the right replacement property shows up before your building sells. In a reverse exchange, an exchange accommodation titleholder (EAT) takes title to a property and holds it for you. The Form 8824 instructions point to Revenue Procedure 2000-37, as modified by Revenue Procedure 2004-51, for these qualified exchange accommodation arrangements.

The clock still runs. Per Publication 544, within 45 days after the EAT takes title to the replacement property, you must identify the property you will give up. The exchange must be completed within 180 days, and the combined time the properties are held in the arrangement can't exceed 180 days. The parked property also has to be financed before your sale closes. This is a job for specialists.

Before you sell a building you may exchange

1. Talk with your CPA about gain, basis and depreciation before you sign anything.
2. Hire a qualified intermediary before the sale closes. Once the money reaches you, it is too late.
3. Get a realistic value on the building you are selling, since it drives how much you need to reinvest. A broker opinion of value is one place to start.
4. Look at replacement properties early, and compare them on the same terms. Our guide to cap rate vs cash-on-cash vs IRR explains what each return measures, and the cap rate calculator runs the basic math.
5. Build your 45-day and 180-day dates into your purchase contracts.
6. Report the exchange on IRS Form 8824 with your return for the year you transferred property.

Get a real number on your building

This article is general education, not legal, tax or investment advice. Use a CPA or tax attorney and a qualified intermediary for any exchange. Every exchange starts with a realistic value for the building you are selling. For a broker opinion of value (no charge and no obligation; we're paid only if you later hire us to sell or lease), call or text 801-664-3370. It is not an appraisal. It is a licensed broker's view of likely price, based on your income, leases and the current market.

Stockton Farnsworth, Utah Associate Broker, Team Utah Commercial, brokered by RE/MAX Associates.

General education only, not legal, tax, investment or appraisal advice. Information is believed reliable but not guaranteed. This article was drafted with the help of AI from the sources listed. Published by Stockton Farnsworth, Utah Associate Broker, Team Utah Commercial, brokered by RE/MAX Associates.