In an arm’s length transaction, the buyer of a product does not have a preexisting familial or business relationship with the seller. For instance, if an investor were to sell their sibling an apartment building, the transaction would not be arm’s length, while if they sold a stranger the building, it would be an arm’s length transaction. This has important consequences when it comes to buying and selling commercial real estate.
When an individual profits from selling an asset, such as stock in a company, commercial real estate, or other investments, a capital gain has occurred. Instead of paying ordinary income tax, an individual generally must pay a special tax rate on these gains, known as the capital gains tax. However, this depends on how long the asset has been held. If you’re a commercial real estate investor, understanding the impact of capital gains taxes-- and how to minimize that impact, is essential if you want to maximize the profitability of your investment.
When an investor or developer sells a commercial property, they'll usually have to pay taxes then and there-- but not always. An IRS 1031 exchange is a transaction that allows a commercial property seller to defer paying taxes on the sale of the property if they use the funds to buy another, similar property within a specific period of time.