Interested in deferred taxes? Internal Revenue Code Section 1031 allows that “no gain or loss when shall be recognized on the exchange of property held for productive use in trade or business, or for investment, if such property is exchanged solely for property of like kind which is to be held for productive use in trade or business or for investment.” This means when selling real or personal property held for business or investment, the federal and state capital gains and recaptured depreciation taxes can be deferred indefinitely or until the replacement property is sold.
Benefit of Deferred Taxes
In a 1031 exchange, the federal capital gain tax rate ranges from zero to 23.8 percent for real property and 28 percent for collectibles such as artwork, vintage cars, numismatic coins, silver and gold bullion. Add the state capital gains and twenty five percent recaptured depreciation tax and the potential tax is upwards of 40 percent.
1031 Exchange Examples
If your intent is to replace with like-kind property, then defer the tax and receive an indefinite, interest free loan for use towards the replacement property purchase. Milling machine operators of Roadtec RX-900e equipment who own their equipment for use on county and state highways utilize 1031 exchanges to defer the recaptured depreciation tax when selling their used machines and replacing with either new or used equipment. The tax represents additional interest free operating cash.
Taxpayers who own Midwest farmland use 1031 exchanges to defer the realized gain when replacing with a vacation rental property along the Gulf Coast. 1031 exchanges allow deferred taxes enabling the taxpayer to:
- Relocate an asset
- Replace an older less efficient business aircraft with a more efficient and equipped aircraft
- Consolidate assets into one or diversify into many
Steps of a 1031 Exchange
One of the first steps is to visit with your tax counsel to determine the tax consequences of selling an asset. Once it is determined a tax is due, is it your intent to acquire a replacement? The next step is to place your asset on the market and engage a Qualified Intermediary to understand how a 1031 exchange works. How you own the property and whether the parties you sell to and buy from are related is important to understand. Whether you are selling Federal Communication Commission TV or radio licenses, gold bullion, livestock or real property, the mechanics of a 1031 exchange are identical. The outcome of a 1031 exchange is deferred taxes.
1031 Exchange Rules
Basic 1031 exchange rules include:
- Like kind property for like kind property. Personal property cannot be exchanged for real property and vice versa. Property held predominantly outside the US can only be exchanged for property held internationally.
- Debt retired and net equity in the old property sale must be equal to or greater in the replacement.
- The taxpayer who sells is the taxpayer who buys.
- Replacement property must be identified and acquired no later than the 45th and 180th calendar day post-closing.
- The replacement property Purchase and Sale Agreement (PSA) must reflect assignment language. Though in short sales and foreclosures, the PSA is not assignable.
- Taxpayer cannot have access to or benefit from the exchange proceeds during the exchange.
- Taxpayer cannot own both the replacement and the relinquished or old property at the same time in a reverse exchange.
- Internal Revenue Service Form 8824 is used to report the 1031 exchange when filing your federal return.
Want to learn “Ten Reasons Why a 1031 Exchange Makes Sense?” Click on the button below to receive this free three page offering. Within seconds the PDF file will be emailed to your inbox.
