1031 Exchange Bidder Insights
The bidder’s position in the1031 exchange cycle is one of the major factors affecting their bids behavior. Timing of the auction in relation to the 45th calendar day post old property closing can influence the bidder’s aggressiveness. Understanding the objective of a 1031 exchange and how it works should lessen the angst of competing bidders if the 1031 bidders are known. Ultimately, the bidding is not about the quantity of 1031 funds available but more importantly the bidder’s value point.
The 1031 Exchange Strategy
The 1031 exchange strategy allows for the deferral of the federal and state capital gains and recaptured depreciation taxes, which can represent 40% of the properties sales price. According to the Internal Revenue Code (IRC) Section 1031 “no gain is recognized when property held for use in a business or investment is exchanged for like kind property held for productive use in a business or investment.” Property refers to both real and personal property. The tax deferral serves as an interest free loan allowing for using those taxable dollars towards the purchase of a replacement property given the new property is equal to or greater than the property sold. The reward is that when the capital gains tax is ultimately paid, the risk of a higher tax rate is compensated for by either annual cash flow, a conservative appreciation or both on the replacement property.
What Affects the Exchangor’s Aggressiveness
Factors affecting the bidder with 1031 money, referred to as the Exchangor include:
- Is the land adjacent to their existing property?
- Quality of soil, history of crop production, topography, and water source
- Has the Exchangor closed or in contract on their property?
- If their property sold, is the auction before or after the 45th calendar day post old property closing?
There are two types of exchanges, a forward and a reverse. In a forward exchange, which is the most common type, the old property is sold before the new property is purchased. In a reverse 1031 exchange, the new property is purchased before the old property is sold. A reverse is a bit more complex and expensive. The opportunity to defer the tax in the exchange can be lost if the old property does not sell within 180 calendar days. In addition, the farmer now owns two properties, and a Qualified Intermediary fee has been paid. The only reason the Exchangor may risk a reverse 1031 exchange is they have a buyer for their old property and a closing date scheduled. More importantly, they want to get the new property off the market now because it is undervalued or the Exchangor really wants the land.
Given today’s economy, many landowners would not favor taking a risk, and would prefer using a forward exchange. Consequently, they have two polar milestones:
Formally identify the replacement property to the Qualified Intermediary by the 45th calendar day post closing on the sale of their old or relinquished property