2023 is underway! Below are key trends, issues and points regarding 1031 Exchanges and commercial real estate.
1031 Exchange Trends and Market Update 2023
The recurring question is, after a robust 2022 for Commercial Real Estate and 1031 Exchange transactions, what’s in store for 2023?
With a new business cycle notably marked by higher interest rates, inflation, and slower growth, the Commercial Real Estate industry has a more pessimistic outlook which will also impact the number of 1031 Exchanges that may occur. It will be a year of challenges and of opportunities.
The pace of Commercial Real Estate transaction volume has continued to trend down with the interest rate hikes.
The pandemic spurred structural shifts in how certain property types are used. This is expected to continue. With more employees continuing to work remote or hybrid, the need for office space will continue to shift as needs are re-evaluated. The weakening of demand will cause more office buildings to be turned into retail or residential, and retail buildings will become office or industrial or residential or mixed use, while other properties will be scrapped for developable land.
The housing market will continue to be negatively impacted by rising interest rates and housing market activity is likely to stay low. Higher mortgage rates and near record price levels make ownership, especially for first time homebuyers, less attainable. However this will support continuing growth in the rental house market spurring opportunity for single family home and multifamily investment.
Multifamily and industrial are predicted to remain popular asset classes, and retail with repurposed class usage, and hospitality, particularly with the growth of Airbnb and VRBO rental investment, will continue. These asset classes generally structure their transactions as 1031 Exchanges.
On the Washington DC front, as a result of a very active multiyear effort to educate Representatives and Senators of the importance of 1031 Tax Deferred Exchanges to the US economy – which was supported by updated economic studies, Section 1031 remained unchanged in 2022. As we enter 2023, it will be necessary to continue those efforts as well as proactively educate new members of Congress of the legitimate, economically important benefits of Section 1031. We also will be watching for the Administration to issue its proposed budget within the coming months and remain prepared to respond to any threats to IRC Section 1031. As always, IPX1031 will continue to issue periodic legislative updates.
With the anticipated market challenges, 1031 Tax Deferred Exchange transactional activity should be slower than the unprecedented pandemic era volume. However, 1031 activity will remain resilient. There will continue to be many opportunities for educated investors and commercial property owners to utilize the strength of 1031 tax deferral.
1031 Exchange trends for 2023 we are anticipating:
- Prices of properties will continue to decrease.
- Properties are on the market longer due to high interest rates
- More investors will be using Adjustable Rate Mortgages (ARMs). These interest rates are typically lower than a traditional 30-year fixed, but adjust to market rate when the ARM matures in 5, 7 or 10 years. As one banker recently commented, “Customers will realize that they are dating the rate, but marrying the property.” Meaning that they can be serious about buying the piece of real estate that they want but don’t have to stay with the interest rate long-term. Once rates decline owners will refinance to a fixed rate mortgage product.
- As interest rates continue to rise and property values begin to decline, more “all-cash” investors will utilize 1031 Exchanges.
- As the market has softened, more investors will patiently wait to sell, or convert all or part of their primary residence to qualifying investment property as they expect prices to rebound.
- Market uncertainty may not affect 1031 Exchange transactional activity for commercial, industrial and multifamily apartments. These sectors will outpace office, and single family rental activity.
- Continued increase of qualifying vacation home rental property purchases in warmer climates or other vacation or remote-working locations with high short-term rental income.
2023 Capital Gains Tax Brackets
2017 tax reform indexed the Long-Term Capital Gain rate breakpoints (whether a 15% or 20% rate) to inflation. The actual rates didn’t change for 2023, but the income brackets did adjust slightly. The breakpoints for 2023 are as follows: married filing jointly: $553,851+ and single filers: $492,301+. The capital gains brackets are based on “Taxable Income” whereas the Net Investment Income Tax thresholds are based on “Adjusted Gross Income”.
1031 Exchange Checklist
A 1031 Exchange transaction requires planning, expertise and support. Here’s a checklist outlining key steps in your exchange.
- Choose your 1031 Qualified Intermediary (QI)
- Consult with your tax professionals
- Include Cooperation Clause language in your purchase and sale agreement
- QI prepares your exchange documents
- Start searching for Replacement Property
- Sign all documents QI prepares
- Sell your Relinquished Property
- Identify your Replacement Property
- Enter into contract on Replacement Property
- Contact QI once Replacement Property escrow is opened
- Close on Replacement Property
- QI transfers funds to complete your purchase
- Your exchange is complete
Tax Straddling: Pay Taxes in 2023 or 2024?
If your transaction closed at the end of 2022 and you are unable to find new property to identify or purchase the property that you have identified, you may still be able to defer paying taxes on your capital gains until 2023. Since you will receive your 1031 funds back in 2023, in certain circumstances, since you did not have control/possession of your funds until 2023, the IRS may allow you to pay taxes on your 2023 tax return, which are due in 2024. This is in accordance with IRC Section 453(d) and requires your accountant to file specific tax forms. Ask your accountant if you are eligible to take advantage of this “mini” tax deferral.
IPX1031 – Choose the Experts
IPX1031 is the largest and one of the oldest Qualified Intermediaries in the United States. As a wholly owned subsidiary of Fidelity National Financial (NYSE:FNF), a Fortune 500 company, IPX1031 provides industry leading security for your exchange funds as well as considerable expertise and experience in facilitating all types of 1031 Exchanges. Our nationwide staff, which includes industry experts, veteran attorneys and accountants, are available to help you and your legal and tax advisors. For additional information regarding IPX1031 and questions on 1031 Exchanges, please review:
Read PAST years’ 1031 trends
1031 Exchange Trends 2022
1031 Exchange Trends 2021
1031 Exchange Trends 2020
1031 Exchange Trends 2019
1031 Exchange Updates & Impacts 2018
1031 Exchange Trends for 2017
1031 Exchange Trends for 2016