You might consider a like kind exchange, also known as a 1031 Exchange referring to the section of the U.S. Tax Code that governs such swaps. Section 1031 of the tax code allows for the deferment of the capital gains tax when one piece of investment or business property is exchanged for a similar or like-kind property. If you are considering doing a 1031 Exchange, or if you’re just curious about this type of investment option here are some important facts you should know.
- A 1031 Is Generally For Investment/Business Property – You cannot swap your primary residence for another personal residence. There is other favorable tax treatment available for the sale of your principal residence.
- “Like-Kind” Is Broad– You can exchange an apartment building for raw land, or a ranch for a strip mall.
- A “Delayed” Exchange Is An Option – Typically, an investor sells one property and then buys a second property within a time frame specified by statute. A qualified intermediary holds the cash or boot from the proceeds of the sale and then uses it to buy the replacement property for the investor.
- You Must Identify Your Replacement Property Within 45 Days – There are two rules in regards to timing when dealing with a 1031 Exchange. The first relates to the designation of the replacement property. Once you sell your property the intermediary will receive the cash. If you directly receive the cash then it cancels the 1031 treatment. Also, within 45 days of the sale of your property you must designate the replacement property in writing to the intermediary specifying the property you want to acquire.
- You May Designate Multiple Replacement Properties– According to the IRS, you can designate three properties as the replacement property as long as you eventually close on one of them. Alternatively, you can designate more properties if you come within certain valuation tests. (Consult your tax adviser!)
- You Must Close Within 6 Months – You must close on the new property within 180 days of the sale of the original property. Be advised that the two time periods run concurrently. That means you start counting the days once your original property closes. If you designate a replacement property 45 days later, then you’ll have 135 days left to close on the replacement property.
- Cash Is Taxed– If you have cash left over after the intermediary acquires the replacement property they will pay it to you at the end of the 180 days. That cash will be taxed as partial sales proceeds from the sale of your property, generally as a capital gain.
- You Need To Consider Differences In Mortgages And Debt – A lot of people get into tax trouble when they fail to consider the difference in the amount of the loan on their old property and the amount of the loan on the new property. If you don’t receive cash back but your liability goes down, that will be considered income to you just like cash. For instance, if you had a mortgage of $500,000 on the old property and the mortgage on the new property is $400,000 then you have $100,000 of gain that will be taxed.
If you have an investment property which is not returning the profit you expected or your tenants are tiresome, perhaps it is time to consider a 1031 exchange. We are happy to talk with you about the market value of your current investment property and other properties for which you can swap. We work with several excellent title companies and qualified intermediaries who will assure that you have a seamless transaction with no hiccups. Our goal is to help you maximize your assets and minimize your time spent managing your real estate portfolio!
Please note that we at the Lise Howe Group do not function as tax advisers, lawyers or qualified intermediaries. We are happy however to be your Realtor for life!