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1031 Exchange on Your Ground Lease

If tax concerns have clouded your plans to sell your ground lease, consider a 1031 exchange. The general concept is that you get to keep all of the proceeds from the sale of your property as long as you invest them in a like kind property. Since taxes are deferred, a 1031 exchange also allows you to buy a more expensive property since you keep more money in your pocket.

But wait a minute. If a 1031 exchange is about selling one property and buying another, how can you participate by selling your ground lease? The answer is that by placing an easement under the cell tower, billboard, solar farm panels or wind turbine (which can simply mirror the existing easement, if there is one), it turns your ground lease sale into a real property sale, generally making it eligible for a 1031 exchange. Having an easement generally does not affect your ownership of the land, including your ability to sell it.

1031 Exchange on Your Ground LeaseBroadly speaking, a 1031 exchange is a swap of one business or investment asset for another. In effect, you can change the form of your investment without (as the IRS views it) cashing out, or recognizing a capital gain. That allows your investment to continue to grow tax deferred. There’s no limit on how many times or how frequently you can do a 1031. You can roll over the gain from one piece of investment real estate to another to another and another. Although you may have a profit on each swap, you avoid tax until you actually sell for cash in the future.

Any property held for productive use of trade or business or for investment can be exchanged for any other property held for productive use in trade or business or for investment – that’s the definition of “like-kind.”

The key benefit of a 1031 is that it preserves all of the equity in a property, but there are other benefits. The preservation of equity increases your purchasing power, allowing you to buy a more expensive property than if you had to pay capital gains tax on the sale of your property. It also allows you to diversify your investments without paying an immediate tax consequence.

When you sell the “relinquished” property and purchase the “replacement” property at a later date, it’s called a delayed exchange. The “exchange period” time limit to buy a new property is 180 calendar days or your next tax filing date, whichever is earlier.

You also have to identify the replacement property or properties within 45 days of selling your relinquished property. This 45-day timespan is called the “identification period” and it is part of the 180 day exchange period. You may identify up to three properties of like value or as many properties as necessary to total the fair market value of the property you are exchanging.

The 1031 exchange rule also governs the proceeds of the sale. A qualified intermediary (QI) must handle the proceeds from the sale. You or your agents or anyone else cannot receive or manage proceeds or they will become taxable. Keep in mind also that all proceeds from the original sale of the relinquished property has to be reinvested in the new property. Any proceeds retained are taxable.

A second key rule in a 1031 exchange requires that the replacement property must have the same or higher level of debt than the relinquished property sold. If it falls short, the buyer will either have to put more money into the replacement property or pay taxes on the shortfall.

IMPORTANT TAX NOTICE: Landmark does not provide advice on any income tax, capital gains tax or other tax requirements or issues related to any transaction in which Landmark is a party or participant in any fashion. Use of any information obtained from Landmark or its affiliates or agents or referral by Landmark or its affiliates or agents is for general information only and does not represent tax advice either express or implied. You are encouraged to seek professional tax advice for tax questions and assistance. The information above is provided as a general introduction to the 1031 exchange process. Prospective sellers and buyers of real estate should always consult their attorney and tax advisor prior to entering into a 1031 transaction.