The Relinquished Property in a 1031 Tax Deferred Exchange

When entering into a 1031 tax deferred exchange in order to defer capital gains taxes on the sale of real estate that has increased in value, (either through market appreciation or through the taking of depreciation), the property that is being sold is known as the “Relinquished Property.”

One definition of the Relinquished Property is:

“The first property transferred in a tax-deferred exchange. The property for which the exchange is made is called the Replacement Property.”

Often, the owner of the Relinquished Property is motivated to sell the Relinquished Property for a number of compelling reasons, including the desire to:

• Unlock the equity that is tied up in an appreciated but underperforming property;
• Decrease the time spent on managing a management-intensive property;
• Acquire a higher quality property;
• Acquire a property which produces a maximum of consistent income; or
• Achieve increased property type and geographical diversification.

There are certain financial characteristics of the Relinquished Property that are important in a 1031 tax deferred exchange. These characteristics include: the sale price level, and the equity and the debt level of the Relinquished Property. In a nut shell: to accomplish a fully tax-deferred exchange the rule of thumb is: exchange even or up in value; and exchange even or up in equity and in debt. By this it is meant that the Replacement property should have a purchase price at least as great as the sale price of the Relinquished Property; and that the Replacement Property should have equity and debt levels that are at least as great as those of the Relinquished Property. It should also be noted that an increase in the purchase price of the Replacement Property over the sale price of the Relinquished Property typically acts to increase the depreciation available to the exchanger in order to provide additional tax sheltering of the income generated by the Replacement Property.

FAI Exchange and Sourcenet Investment Services, LLC can help you identify and purchase suitable Replacement Properties, including Delaware Statutory Trust (DST) investments, which can help simplify a 1031 exchange. DSTs also allow for diversification of real estate investments and also have relatively low minimum investment requirements. And with a DST investment, investors can gain access to institutional grade properties, which otherwise might be out of the reach of many investors.

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