A 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which allows you to avoid paying capital gains taxes when you sell an investment property and reinvest the proceeds from the sale within certain time limits in a property or properties like kind and equal or greater value.
Not dissimilar to the photo below showing the progress of the famous tower, a 1030 Exchange can allow an investor to keep building up a real estate portfolio. Unfortunately, skilling environmental due diligence on a commercial site can be a costly mistake when remediation is needed.
As a real estate investor, a 1031 Exchange can allow you to leverage your investment in real estate. In the environmental due diligence world, we find that 1031 Exchanges tend to skip over environmental due diligence, which places the parties involved at risk. People need to understand, that the owner of the property = the RP. (RP = Responsible Party). Even in situations where the seller agrees to perform the remediation, we have seen RP's disappear and regulatory agencies will also look toward the owner of the real estate.
Generally speaking A Phase I Environmental Site Assessment should be performed for all commercial real estate transitions, including 1030 exchanges. Learn About Phase I
Let's start with the appeal of the 1031 Exchange
First, it allows an investor to pick a new property that allows a greater ROI or diversify the portfolio of properties.
You can use the exchange to consolidate several properties into one asset or vice versa acquiring more properties in exchange for one more valuable one, possible for estate planning.
On an accounting basis, you can reboot the depreciation clock. Meaning rather than simply selling one property and buying another one the 1031 exchange allows you to defer capital gains tax, thus freeing more capital for investment in the replacement property.
That all sounds great right? Well, the environmental rub is there are time frames for 1030 to execute and we are finding many people have skipped over doing environmental due diligence including Phase I, II & III. The rub is all Phase I studies follow an outline established by ASTM. ASTM updates the standard every 8 years. Generally speaking, when a change occurs Phase I becomes more inclusive. a Phase I from 20 years ago would be a faster read than one today. So you can expect that today's Phase I will be more thorough.
The oil that leaked from this previously sealed pit is now the owner's responsibility to address.
How do you protect yourself with a 1030 Exchange?
Real estate transactions are complicated and 1031 Exchanges add a short window to identify properties, which makes people cut corners.