A 1031 exchange into neighborhood retail, explained by a CCIM: the 45- and 180-day timelines, how boot happens, and how to judge a replacement property.
Photo: Land O'Lakes, Inc. / Unsplash
This is general information, not tax or legal advice; talk to your own tax adviser and qualified intermediary.
During my years with a national investment brokerage in St. Louis, I met a lot of buyers who were in an exchange. They had a clock running and a gain to defer, and the pressure of that clock was the biggest risk to their decision. The tax rules are only half the job. The other half is buying a property you actually want to own.
What is a 1031 exchange?
Section 1031 of the Internal Revenue Code lets you defer tax on the gain from selling real property held for investment or business use, if you reinvest in like-kind real property under the rules. For real estate, like-kind is broad: an apartment building, a warehouse, land held for investment and a neighborhood retail center can generally serve as replacements for one another.
The sale proceeds go to a qualified intermediary, not to you. If you take control of the money, the exchange generally fails.
What are the 1031 exchange deadlines?
- Day 0: the relinquished property closes and the proceeds go to the qualified intermediary.
- By day 45: identify replacement property in writing under one of the identification rules, such as the three-property rule.
- By day 180: close on the replacement property, or by the due date of your tax return for that year, including extensions, if that comes first.
The two periods run at the same time, not one after the other, and they do not stretch for weekends or holidays. That is why I tell exchange clients to start looking for replacement property before the sale closes.
What is boot in a 1031 exchange?
Boot is anything you receive in the exchange that is not like-kind property. It usually shows up two ways. Cash boot is net proceeds you do not reinvest. Mortgage boot is debt relief: you paid off a loan on the property you sold and did not replace it with equal debt, or with added cash, on the property you bought.
Here is a simple example in the exchange calculator, with round, hypothetical numbers.
- Realized gain
- $1,200,000
- Boot (cash + net debt relief)
- $200,000
- Gain recognized this year
- $200,000
- Gain deferred
- $1,000,000
Defer it all by buying equal or greater value, reinvesting all net equity, and replacing debt paid off with new debt or added cash. Closing costs and depreciation recapture are left out. General information only, not tax or legal advice; talk to your own tax adviser and qualified intermediary. The example figures are illustrative, not the terms of any property.
Open the full calculator →Worked by hand, ignoring closing costs: the gain on the sale is $1,200,000. The investor reinvested all $1,400,000 of equity, but traded down $200,000 in value and replaced $600,000 of debt with only $400,000. Unless that gap is covered with additional cash, about $200,000 of the gain would generally be recognized as boot and the rest deferred. Trading down in price is the most common way exchangers create boot without meaning to.
Why consider neighborhood retail as replacement property?
I hear this question from owners selling apartments or older industrial buildings who want something easier to manage. Neighborhood retail can fit, with conditions.
- Lease structure. Many retail leases are NNN, so tenants reimburse taxes, insurance and CAM. That lightens the management burden, though it does not remove it.
- Spread of income. A multi-tenant center collects rent from several businesses rather than one.
- Daily-needs tenants. Service users such as restaurants, salons, wireless stores and professional offices give people a reason to visit regularly.
- Divisible risk. Losing one tenant out of several is a different event than losing the only tenant.
The conditions are real. Re-leasing a small suite takes time and money. Local tenants carry different credit than national brands. And a center's income is only as good as its leases, which is why I underwrite NOI first and price second.
Management is different too. In a multi-tenant center, someone has to collect CAM estimates, run reconciliations, handle tenant requests and plan for roof and parking lot replacement. That work can be hired out, but it should be priced into your NOI, not assumed away.
How do you judge a replacement property under a deadline?
The clock pushes buyers toward the first property that matches the dollar amount. Resist that. Before day 45, I want each identified property to clear the same tests I would use with no deadline at all:
- Read the leases, not just the rent roll.
- Rebuild the NOI yourself, including vacancy and non-recoverable expenses.
- Compare remaining lease term with your intended hold.
- Do real due diligence on title, survey, zoning, access and environmental.
- Identify backups, because deals fall through.
My colleague Matthew Danner, Windfield's development associate, wrote a due-diligence checklist for retail sites that is a useful companion here, and Andrew Danner's piece on reading a cap rate covers the pricing side.
Work through title, survey, zoning, utilities, access and environmental with Matthew Danner's checklist.
What if you cannot find enough replacement property?
Sometimes the right property is smaller than the one you sold. That is not a failed exchange. It is a partial one. You defer tax on what you reinvest and generally recognize gain on the rest. For some owners, taking some cash out and paying tax on it is a reasonable choice, made on purpose, rather than an accident.
The mistake is drifting into a partial exchange because the deadline arrived first. Decide early whether you want full deferral, and set your target price, equity and debt to match. Your qualified intermediary and tax adviser can tell you exactly what those targets need to be for your situation.
Where does The Shops at Smithville fit in this conversation?
The Shops at Smithville is a 30,150 SF center on U.S. 169 north of Kansas City that Windfield is leasing now. I bring it up not as an exchange offering but as a live example of what exchange buyers should study: how a center gets leased, who the tenants are and how the mix holds together.
Committed tenants so far include a pizza shop, AT&T, a nail salon, an HVAC company and an accountant. The remaining 18,680 SF is in four spaces, including the standalone 10,000 SF South Building. Watching a center lease up teaches you what to look for in one that is already stabilized.
See the site plan, the committed tenants and the available spaces.
Representing a tenant who needs space north of Kansas City? See the Smithville page for cooperating brokers.
Windfield is a member of CORFAC International, with affiliates in 70+ markets, which helps when the right replacement property is not in Kansas City. If you are planning an exchange, call me at Windfield Real Estate, 816-612-5191, before your sale closes, not after.
Planning an exchange? Talk with Ben Nelson, CCIM, before your sale closes.
Questions people ask
Can I exchange an apartment building into a retail center?
Generally yes. For real estate, like-kind is broad: real property held for investment or business use can usually be exchanged for other real property held for investment or business use, regardless of type. The details of your situation still matter, so confirm with your tax adviser and qualified intermediary before you commit to a structure.
What is the three-property rule in a 1031 exchange?
It is the most commonly used identification rule. Within 45 days of selling, you can identify up to three potential replacement properties of any value, and then acquire one or more of them within the exchange period. Other identification rules exist for longer lists, with stricter conditions. Your qualified intermediary will confirm which rule you are using.
Is boot always taxable?
Boot is generally taxable to the extent of the gain you realized on the sale. Cash you do not reinvest and debt relief you do not replace are the usual sources. Adding cash to the replacement purchase can offset debt relief, but cash you receive cannot be offset by taking on more debt. Your tax adviser should run the exact numbers.
Can a 1031 exchange buy a building my business will occupy?
Property held for productive use in a trade or business can qualify, which is different from a personal residence. An owner-user arrangement can raise structure questions, especially when related parties are involved, so this is exactly the kind of situation to review with your tax adviser and qualified intermediary before you identify the property.
When should I start looking for replacement property?
Before your relinquished property closes. The 45-day identification window is short, and good retail properties rarely appear on schedule. I suggest building a short list, reviewing leases and drafting a rough NOI for each while the sale is still under contract, so that day 45 is a confirmation rather than a scramble.
Ben is a Certified Commercial Investment Member (CCIM) who advises clients on leasing, acquisitions and investment analysis. Before joining Windfield in 2020 he advised investors in St. Louis and worked in leasing and property management in Columbia, Missouri.
Windfield Real Estate, LLC · Licensed Missouri real estate broker · 816-612-5191 · info@windfieldrealestate.com
