What Are the Options When You Don’t Qualify for a 1031 Exchange?

Conducting a 1031 exchange provides the opportunity to secure indefinite tax deferral at the federal level—and this allows real estate investors and businesses to reinvest proceeds that would otherwise be paid to the Internal Revenue Service (IRS). As a result, for investors and businesses eligible to take advantage of Section 1031, working with a 1031 exchange company to conduct a like-kind exchange will often be the most financially advantageous option.

But what if you don’t qualify for a like-kind exchange?

When real estate investors and businesses don’t qualify to conduct like-kind exchanges, there are a variety of potential alternatives for minimizing (and potentially avoiding) tax liability resulting from the sale of an appreciated property. In some cases, investors may be able to transform 1031-ineligible properties into eligible properties.

5 Potential Alternatives to Conducting a Like-Kind Exchange

Here are five examples of potential alternatives to conducting a like-kind exchange:

1. Conducting an Installment Sale

Selling a property through an installment sale allows the investor or business to spread out the reportable gains resulting from the sale. Not only can this delay liability for some of the tax owed, but it can also reduce the amount of tax owed by reducing the investor’s or business’s total reportable annual income (as compared to reporting the entire sale proceeds in a single year).  

2. Investing in a Qualified Opportunity Zone

Qualified Opportunity Zones are government-designated economically distressed areas that offer tax incentives to investors. If buying a property in a Qualified Opportunity Zone is an option, it can potentially provide an opportunity for tax elimination or deferral.

3. Using a Delaware Statutory Trust (DST)

Delaware Statutory Trusts (DSTs) are investment vehicles that offer a variety of potential benefits. Among them, when structured properly, an ownership interest in a DST can qualify as “like-kind” property for a subsequent 1031 exchange.

4. Conducting a 721 Exchange with a Real Estate Investment Trust (REIT)

Section 721 of the Internal Revenue Code allows real estate investors and businesses to contribute properties to a real estate investment trust (REIT) and receive ownership shares (or “operating partnership units”) in return. This offers another potential means of tax deferral, and investors and businesses can often combine DSTs and Section 721 strategies to achieve even greater tax benefits.

5. Offsetting Capital Gains (Tax-Loss Harvesting) and Other Tax Strategies

If an investor or business has unrecognized capital losses, another option is to recognize gain on the sale of a property and then offset it with available losses that can be “harvested.” Depending on their circumstances, investors and businesses may be able to use a variety of other tax strategies to mitigate or eliminate their tax liability resulting from recognized gain as well.

These are just examples of potential options — and they will not be viable (or available) in all cases. Before committing to any particular tax mitigation or tax deferral strategy, real estate investors and business owners should ensure they give due consideration to each option on the table.

Transforming 1031-Ineligible Properties Into Eligible Properties

Another option that may be on the table in some cases is to transform a 1031-ineligible property into one that is eligible for a like-kind exchange. For example, while flip properties generally do not qualify for like-kind exchange treatment, investors can make them eligible by renting them for a period and taking other steps to meet Section 1031’s requirements. Whether this is the best option available will depend on the amount of tax savings that can be achieved through a 1031 exchange—as well as the investor’s liquidity needs, risk tolerance, and other factors.

In any case, if you have questions about establishing 1031 eligibility or the potential alternatives to conducting a 1031 exchange, your first step is to speak with a professional who can help. At 1031 National Services, we are devoted to helping real estate investors and businesses maximize their return on investment (ROI), and we can walk you through the options you have available.

Contact 1031 National Services | A 1031 Exchange company

If you would like to learn more about the options available when you don’t qualify for a 1031 exchange, we invite you to get in touch. To speak with a specialist at 1031 National Services, a 1031 exchange company, please call  888-872-1031 or tell us how we can get in touch online today.