Like-Kind Exchanges and Distressed Assets: Q&A with First American’s Julie

Billions of dollars in commercial mortgages will mature in 2025, which will increase the number of distressed properties. Julie Baird, president of First American Exchange Company, told Connect CRE that the 1031 exchange process can provide unique opportunities for distressed assets.

Connect CRE: Why is the 1031 exchange process a viable tool for dealing with distressed properties?

Julie Baird: Sellers are likely to be hit with taxable gains and depreciation recapture if they dispose of a property.

Let’s say a property was purchased for $70 million and refinanced at a $100 million valuation but ends up being worth only $80 million—all of which is debt. Even if there’s no cash from the sale, the seller is faced with a taxable gain of $10 million, plus the depreciation capture mentioned above. A 1031 exchange can help the seller defer that tax burden on what otherwise would be a total loss.

Meanwhile, 1031 exchange buyers might be able to secure favorable purchase prices now. Even with the current interest rate environment—which isn’t necessarily ideal—buyers can refinance when rates decrease in the future. In general, 1031 exchange buyers require less debt financing, so they may be able to secure favorable purchase prices more easily than someone who relies only on more debt financing upfront for their purchase.

Also, investors who acquire distressed properties can now benefit from increased property values over the long term due to lowering interest rates and structural supply challenges that keep construction starts low.

Connect CRE: What distressed properties lend themselves well to a 1031 exchange?

Julie Baird: Multifamily is one. Starts are down, so when the current supply leases up, inventory will decrease, and prices will increase. This may present opportunities for investors to purchase multifamily buildings at a lower price point, anticipating future gains.

Meanwhile, the office market is still recovering from the effects of remote jobs and high vacancy rates. In 2025, the office market should see some distressed debt, which could create an opportunity for 1031 exchanges. Additionally, as office prices increase, some of these assets might start looking more favorable for conversion to multifamily units.

Distressed assets may provide a unique opportunity for Build-to-Suit 1031 exchanges. These exchanges let an owner use proceeds from the sale of the relinquished property to acquire replacement property and make improvements to that property. This method requires a holding entity called an Exchange Accommodation Titleholder (EAT), which temporarily holds the replacement property title while improvements are being made. While there are benefits to this method, a build-to-suit exchange is complex with strict timeframes and requires advanced planning with tax advisors and an experienced Qualified Intermediary.

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