Nick Ihnatolya’s phone is ringing a little bit less these days, at least compared to the red-hot commercial real estate market of 2022. That’s because Ihnatolya specializes in “1031 exchanges,” which are named after a section of the federal Internal Revenue Code that enables investors and businesses to defer capital gains taxes on the sale of qualifying properties.
As real estate deals cooled in 2023 due to rising interest rates, there were fewer property sellers willing or able to find a “like/kind” property they could buy to qualify for the exchange.
“You are getting people who aren’t sure they can find property or maybe don’t want to pay the price or can’t afford the financing or are not interested in taking on the financing because of the higher interest rates,” Ihnatolya said.
He has an inside view of what’s happening with 1031 exchanges in the Albany region as manager of Capital Intermediary LLC.
Capital Intermediary shares offices with SMPR Title Agency in Albany and Saratoga Springs, but it’s a separate business.
Ihnatolya, an attorney, is also a partner in SMPR Title Agency.
As its name suggests, Capital Intermediary serves as a go-between for the transactions.
“Our job is to facilitate the exchanges,” Ihnatolya said. “We don’t give [tax or legal] advice. We say you have to have this conversation with your accountant or tax attorney.”
“We hold the money,” he added. “We have the documents executed, and then when they’re ready to buy we release the money.”
There are various types of exchanges, each with their own processes: simultaneous, deferred, reverse and construction.
Capital Intermediary was created in 2002 because some customers of SMPR Title were asking about 1031 exchanges but couldn’t find a local person to facilitate them.
“Sending your money, which could be millions of dollars, to a company you have no idea who they are, what they are and out of the area, sort of scared people,” he said.
Here, Ihnatolya explains more about exchanges and his expectations for 2024.
People you would think know the ins and outs of commercial real estate don’t necessarily know how 1031 exchanges work. Is that true? 100% accurate. It does not cease to amaze me, whether it’s a customer, attorney or accountant. Usually they say they know enough to [ask questions]. It’s a team effort at the end of the day.
What’s the biggest misconception or assumption people make about 1031 exchanges? A lot of times people don’t realize they have to hold [the property] for investment purposes. People think they can do a flip. You can’t do that with an exchange. The other misconception for someone trying to do an exchange is they’re buying property from a relative. Depending on who the relative is, it may not be permissible because it’s a related-party exchange. The IRS has said if you’re buying from a related party, if it’s a spouse or a child, you can’t do an exchange.
People also think they can do it retroactively, correct? Yes. They go and sell the property and then reach out to me. If the exchange was not set up in advance of that sale, you can’t do it.
What’s the definition of “like/kind” real estate? Under the IRS it’s real estate you held for investment purposes. You can sell a two-family and buy retail property, and vice versa [for the exchange]. The key feature is holding it for investment.
How many years do you have to hold onto the investment before selling the property? It’s interesting because the IRS doesn’t give you [an exact number]. I hear from accountants a range: two years, three years, sometimes I’ve heard seven years. What’s most important is you can’t go in with the intent of buying property and selling it within a year or two. You can’t have the intention of flipping it.
When you say “set up the exchange” before the sale, what does that mean? It means we take the information. We have a portal, we send a link. You fill in the info and that populates into an exchange agreement. That has to be signed prior to the sale happening.
Does a buyer need to know which property they will purchase prior to creating a deferred exchange? No. The clock starts ticking on the closing date for the sale of the property. From date of sale you have 45 days to identify one or more properties you would like to buy as your replacement property. You can ID up to three properties. From 180 days from date of sale you have to buy one or more of the replacement properties.
For those who don’t invest in commercial real estate, they may say this is just a way for rich people to get out of paying taxes. Well, it’s a deferment. Some people think, it’s getting me out of paying taxes. What you’re doing is kicking the can down the road. You’re deferring capital gains until you sell that replacement property. You have to figure out your tax liability at that point.
Do the properties have to be commercial, not residential? It has to be property held for investment purposes. Some people buy a single-family home with the intent of renting it out.
Is the criteria non-owner occupied? Correct. The criteria is it’s held for investment purposes
What if you own a three-unit home, live on the ground floor and rent the other two apartments? That’s when you get the accountant involved because I have seen where they can prorate it based on the other two units.
Is there a range of property sale prices in which people typically do an exchange? It usually ranges from $200,000 to $800,000. I remind people when they get towards the lower end of the scale to have a conversation with their accountant to find out your tax liability and whether it’s worth doing the exchange. It may be financially better to pay the tax based on what the accountant comes up with.
How much does it cost to set up the exchange? The flat fee for a standard deferred exchange, which is sell one property and buy one property, is $1,250. If you were to buy an additional property it’s $350 for each.
What’s your expectation for the number of exchanges that will be created in 2024? We’re anticipating the same as 2023. It all depends on interest rates and inventory. Those are the big keys to determine if the market will kick back into gear.
Interview has been edited and condensed.