Client Profile
| Industry | Commercial Real Estate Investor |
| Portfolio Value | $3,500,000 |
| Entity Type | LLC (disregarded entity) |
| State | Georgia |
| Key Metric | $1.2M gain deferred on sale |
| Tax Deferred | $280,000 |
The Problem
This investor owned a portfolio of three commercial properties valued at $3.5 million. The investor wanted to sell a strip mall — which had been fully depreciated — for $1.6 million. The adjusted basis was approximately $400,000, creating a potential taxable gain of $1.2 million. The tax bill would have exceeded $280,000.
The investor's prior advisor had not discussed 1031 exchange options and had not conducted cost segregation studies on any properties.
AE Tax Strategy
1. 1031 Like-Kind Exchange Under IRC §1031
We structured a forward 1031 exchange under IRC §1031, engaging a qualified intermediary before closing. The investor identified a $2.1 million medical office building as the replacement property and closed within the 180-day period, deferring the entire $1.2 million gain.
2. Boot Avoidance Under IRC §1031(b)
We carefully structured the exchange to avoid taxable boot under IRC §1031(b). The investor traded up in both value and equity, ensuring zero boot was recognized.
3. Cost Segregation on Replacement Property Under IRC §168
We commissioned a cost segregation study on the $2.1 million replacement building. The study reclassified $630,000 to accelerated recovery periods, generating approximately $148,000 in additional tax savings.
4. Stepped-Up Basis Planning Under IRC §1014
We advised the investor that under IRC §1014, if the replacement property is held until death, the entire deferred gain would be permanently eliminated for heirs through the stepped-up basis.
Before & After Comparison
| Category | Without 1031 | With 1031 + Cost Seg | Benefit |
|---|---|---|---|
| Capital Gains Tax on Sale | $190,000 | $0 (deferred) | $190,000 |
| Depreciation Recapture Tax | $90,000 | $0 (deferred) | $90,000 |
| Year 1 Cost Seg Benefit | $0 | $148,000 | $148,000 |
| Total Benefit | $0 | $428,000 | $428,000 |
Key Takeaways
- A properly structured 1031 exchange defers both capital gains tax and depreciation recapture tax — the combined savings on a fully depreciated property can be substantial.
- Cost segregation on the replacement property creates immediate depreciation deductions that further reduce overall tax liability.
- Boot avoidance requires careful coordination of debt replacement and proceeds handling — even minor missteps can trigger partial gain recognition.
- When combined with a stepped-up basis at death under IRC §1014, a 1031 exchange can convert tax deferral into permanent tax elimination.