Tax Deferred Exchanges
Like-kind exchanges, also known as 1031 exchanges, are and have been used a lot to defer your tax liability on the sale of your property. It states that none of the realized gain or loss will be recognized at the time of the exchange. There are timelines involved. You have 45 days from the closing date of your relinquished property to identify another property. You are allowed 180 days from closing of your original property to close on one of your identified properties.
Any real estate property owner or investor of real estate should consider an exchange when he/she expects to acquire a replacement “like kind” property subsequent to the sale of his existing investment property. Anything otherwise would necessitate the payment of a capital gain tax, which is currently 15%, but may go to 20% in future years. Also include the federal and state tax rates of your given state when doing a 1031 exchange. The main reason for a 1031 is that the IRS depreciates capital real estate investments at a 3 percent per year rate as long as you hold the investment, until it is fully depreciated. When you sell the capital asset, the IRS wants to tax you on the depreciated portion as an income tax, and that would be at the marginal tax rate.
For investors, the auction process can help them perform using 1031 exchanges. You can buy a property at auction and set up a reverse 1031 exchange and still have time to sell one of your other investment properties by auction. This will save you the capital gains on the property you are selling. All in all, make sure you have a good tax attorney or CPA to guide you through these processes.
Four of the most common misconceptions of a 1031:
All 1031 exchanges must involve swapping or trading with other property owners…… (NO)
Before the law changed in 1984 all exchange transactions of real estate required the actual swapping of deeds plus the simultaneous closing among all parties to a 1031 exchange. In most cases it was several parties sitting down and swapping deeds to get this accomplished. Today, there’s no such requirement to swap your own property with someone else’s property in order to complete an IRS- approved exchange. The rules have been refined and ratified to the point that the current process is much more indicative of your qualifying intent, rather than the logistics of the real estate property closings
It is required that all types of 1031 exchanges must close simultaneously……. (NO)
There was a time when this was true. These transactions would all be closed in one day. These days most 1031’s end up closing as a deferred exchange.
“Like-kind” means purchasing the same type of property which was sold……. (NO)
Often the definition of “like-kind” has been misinterpreted or misunderstood to mean “The requirement of the acquisition of property to be utilized in the same form as the exchange property.” In laymen’s term, hotels are for hotels, apartments are for apartments, farms are for farms, etc. This is all true. However, the exact definition is again more reflective of intent than its use. As a result, there are currently only two types of properties that qualify as a ‘like-kind’:
– Property held for investment and/or
– Property held for a productive use, as in a trade or business.
1031 Exchanges must be limited to one exchange and one replacement property……. (NO)
This statement is a perfect example of another 1031 exchanging myth. There are no provisions within either the IRS Code or the US Treasury Regulations that can restrict the amount and number of real estate properties that can be involved in an exchange. Thus, in exchanging out of several properties into one replacement property or the vice versa of selling of one property and acquiring several other properties, are perfectly acceptable strategies and uses of a 1031.
Information from Bruce Wold’s Blog at Real Estate Auctions.