Guide to 1031 Tax Exchanges
1031 Tax Exchange refers to Section 1031 of the IRC Tax Code
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This section allow an investor to defer paying capital gain taxes when selling an asset (real estate)
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Tax “deferred,” not tax “exempt”
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Only investment property or property used for business
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Must replace asset with asset of equal or greater value
Do I ever need to pay taxes on my investment property?
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You can exchange throughout your life (Swap til you drop strategy)
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Allows for a step up in basis at day of death
Advantages
- Capital Gains are eliminated
- Depreciation recapture eliminated
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You can integrate with estate planning allowing value to stay in estate
What is a "Qualified Use" requirement?
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Must have the intent to hold both the relinquished and replacement properties for:
- Rental/Income production
- Investment
- Use in a business
Property held for sale will typically not qualify for 1031 Exchange
- Property acquired to fix up (flips)
- Condo conversions
- Property acquired to develop
What is the "Reinvestment" requirement?
•Investor must have the intent to reinvest in like-kind replacement property
•Investor must trade equal or greater fair market value based on net sales price
•Investor must reinvest 100% of equity/net cash proceeds into replacement property
•Investor can always add cash, but cannot withdraw cash without paying tax
What are "Like Kind" Properties?
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Single Family
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Multi-family
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Commercial office
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Retail
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Industrial
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Vacant land
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Oil and Gas interest
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Mineral interest
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30+ Year Leases
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TIC/DST (fractional property interest)
Non "Like Kind" Properties
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Primary residence
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Property held for sale
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Cash
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Stocks & Bonds
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Mutual Funds & REITs
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Partnership Interest
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LLC Interest
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Shares in Corporation
How long do I have to utilize a 1031 exchange after I sell?
45 Day Identification Period
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Calendar days
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Begins at close of transaction (escrow)
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Must comply with only ONE ID rule:
- Three (3) property rule; OR
- 200% of fair market value rule; OR
- 95% exception
Identification Strategies
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Delay closing date
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Start looking for properties early
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Consider using TIC/DST properties
What does the 180 Day Exchange Period mean?
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Complete your 1031 Exchange
The earlier of 180 calendar days or the due date of your income tax return, including extensions
(only an issue when sale closes between October 17 and December 31 or any given year)
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45 days plus an additional 135 days for a total of 180 calendar days
- Not 45 days plus 180 days
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Begins at close of sale transaction
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No extensions
How Taxes Impact Real Estate Investments?
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2017 Capital Gain Tax Rates
–Minimum Federal Rate is 15%
–Maximum Federal Rate is 20%
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Depreciation Recapture
–Flat Federal Rate is 25%
–State Rate
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Healthcare Reform Tax Rate is 3.8%
–Passive Income over $250,000.00
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CA State Tax Rate (9.3% Average)
–Can reach 13.3% for High Net Worth Individuals
Case Study:
Client purchases property for $500K, holds for 10 years & sells for $1M (Assume HNW investor – higher tax rates)
Total Capital Gain: $ 500,000.00
Less Federal Tax (20%): $ (100,000.00)
Less Medicare Tax (3.8%): $ (19,000.00)
Less CA State Tax (10.3%): $ (51,500.00)
Net Capital Gain $ 329,500.00
Depreciation Recapture Total depreciation taken on investment $185,185.00
Depreciation Recapture Tax (25%) $ (46,296.00)
Net Amount Available $ 283,204.00
Represents a 44% reduction in principal available to reinvest!
Replacement Property Case Study:
Assume investor purchases replacement property with a 50% LTV and a Gross Scheduled income (GSI) of 10%
Utilizing a 1031 Exchange:
Principal available to reinvest $ 500,000.00
Purchase price (50% LTV) $1,000,000.00
GSI per year (10%) $ 100,000.00
Without a 1031 Exchange:
Principal available to reinvest $283,204.00
Purchase Price (50% LTV) $566,408.00
GSI per year (10%) $56,640.00
Difference in Income (per year) $43,360.00!
Types of 1031 Exchanges you can do
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Forward
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Simultaneous
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Delayed
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Reverse
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Exchange First
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Exchange Second
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Build to Suit/Improvement
1031 Exchange – Getting Started
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Qualified Intermediary (QI or Accommodator) must be assigned into your sale and purchase transactions before closing
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Exchange can be opened with copy of contract, preliminary title report, and escrow instructions
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Upon closing of relinquished property, proceeds are wired to QI and held until acquisition of replacement property
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QI’s role is to draft legal documents, advise and structure exchange, and defend if audit occurs
Are you looking to sell an investment property in the near future? Contact us today for more information on your 1031 Exchange options. We provide 100% free personalized consultations.
