SELLING A COMMERCIAL PROPERTY

HOW SELLING A COMMERCIAL PROPERTY SHOULD BE

Unlike Maryland residential properties that can be handled without the involvement of a real estate professional (a real estate agent), Maryland commercial real estate transactions require a higher level of complexity and as a result, real estate professionals handle almost all commercial real estate transactions. In fact, the courts view individuals and business entities that partake in commercial real estate as “sophisticated” parties. As such, they are presume to have access to information and representation by counsel which means that they would be penny wise and pound foolish not to work with an experienced commercial real estate professional which can drastically mitigate their exposure to risk.

To be clear, there are usually two situations that arise where an individual or company will want to sell a commercial property.

They include:

1. A GROWING BUSINESS. A common scenario of when an individual or business entity decides to sell their existing commercial space is when they have been in business for some time and have outgrown their current space and need an entirely new space.
2. AS AN INVESTOR. Sometimes, investor of a commercial property will want to sell a current property to cash out their investment or, they may decide to sell in order to re-invest in another property that offers a larger return on investment.

When The Property Is Ready To Be Placed On The Market, The Question Becomes, “Should We Use A 1031 Exchange?”

A 1031 Exchange refers to taking advantage of IRS Tax Code Section 1031. This tax code allows a real estate investor to swap their investment on one real property with another one. By doing so, the investor can defer taxes on the capital gains made during the initial real estate investment

Consider this example of how a 1031 exchange works:

1. You invest in a commercial real estate property, Property A.
2. Through your investment in Property A, you make $250,000 in net profit.
3. If you were to pay a combined capital gains tax of 23% on your profit, you would owe the IRS $57,500. As a result, you would only make $192,500 true profit from your investment in Property A.
4. However, if you decide to reinvest the entirety of your $250,000 profit into a new commercial real estate property, Property B, you do not have to pay the combined capital gains taxes from Property A.

Thanks to Section 1031, as long as you reinvest your investment profit in a “real property of like-kind“ then your trade of properties nullifies the gains or loses made from your initial investment.

When Do You Need a 1031 Exchange?

You get a 1031 exchange when you want to grow your investment portfolio without enduring capital gains taxes. If you’re a real estate investor that wants to reinvest your profits into new business adventures, you should consider a 1031 exchange. Remember, you cannot take any profits from your initial investment – they need to be directly exchanged for new real property.

You must apply for a 1031 Exchange within 45 days of closing on your commercial real estate investment. During this 45 day window, you need to identify your replacement real property for the 1031 Exchange. An investor may choose to nominate up to three replacement properties for their 1031 Exchange approval. After the IRS approves the 1031 Exchange, the investor has 180 days to secure the purchase of their new real property.

Selling Commercial Real Estate with a 1031 Exchange

Here’s what a commercial real estate seller using a 1031 Exchange needs to know:

– Subsidized Closing Costs. You can use funds from a 1031 exchange to pay for qualifying costs associated with closing on your real property. Some  closing costs that qualify are finder’s fees, sales commissions on the property, legal and notary fees, property taxes and more.

– Unsubsidized Closing Costs. 1031 exchange funds cannot be used to cover certain closing costs, including application fees, property utilities, security deposits, mortgage insurance, property liability insurance and more. For a full understanding of what costs are covered and which aren’t contact you real estate attorney or financial manager.

– Extra Cash Gets Taxed. It’s common for a percentage of profits to be leftover after your exchange on real property for another. If you receive this leftover in the form of cash, you will need to pay the applicable capital gains tax.

As you can see, the process can be complicated and there are a lot of details that need to be properly addressed. For a seller on their own, the process can be confusing and frustrating and it is very possible key details may be overlooked. It is important for a seller to work with a real estate attorney  and a trained commercial real estate agent to ensure the entire process goes smoothly and efficiently. When you hire our firm, we can make sure that you both your legal and real estate interests are protected.