When a taxpayer realizes a gain on the sale of property, the taxpayer typically owes capital gains taxes on the amount realized. One method often utilized by taxpayers to avoid the payment of capital gains taxes is to enter into a Section 1031 Exchange instead of a traditional sale. When a transaction qualified for Section 1031 treatment the capital gains taxes that would otherwise be due are deferred. When a non-resident alien, or foreign, investor is involved the rules become a bit more complicated.
Andy Gustafson
Reverse 1031 Exchange with Multiple Related Parties
In an effort to defer the payment of capital gains taxes, a taxpayer may choose to enter into a Section 1031 Exchange in lieu of a traditional sale of property. A Section 1031 Exchange may be used by a corporate entity as well as by an individual taxpayer; however, the rules for qualifying a transaction for a 1031 Exchange become more complicated as the entities involved become more complex. In IRS PLR 201242003, the IRS considered whether Section 1031 applies in a transaction in which the taxpayer and a related party both entered into separate qualified exchange accommodation agreements to park the same property held by a single exchange accommodation titleholder.
Aircraft 1031 Exchange: State Sales and Property Tax
A 1031 exchange allows the owner of an aircraft held in the productive use of a trade or business to defer the federal and state capital gains and recaptured depreciation taxes when selling, given the Internal Revenue Code Section 1031 Regulations are strictly followed. Even though the aircraft selling price may be lower than when it was acquired, the depreciation or bonus depreciation taken can be hundreds of thousands of dollars and deferred in a 1031 exchange. In effect, the tax deferral is an indefinite interest free loan available to all US and non-resident federal taxpayers. States can impose a sizable personal property aircraft and sales tax if the taxpayer and Qualified Intermediary (QI) are not careful.
1031 Exchange and Short Sale
Mixing a 1031 exchange and a short sale can be done, but often times cannot. Timing can have alot to do with it. A 1031 exchange allows the taxpayer to defer the federal and state capital gains and recaptured depreciation taxes when selling real estate held in the productive use of a business or for investment. After aggregating the taxes triggered upon sale, the tax can be as high as 40 percent of the sales price. If the taxpayer, who can be an individual, husband and wife, trust, corporation, or domestic or foreign follows the 1031 rules, those taxable dollars can be used towards purchasing replacement property and the taxpayer effectively receives an indefinite interest free loan. The tax is ultimately due when the replacement property is sold, unless deferred again in another 1031 exchange.
1031 Tax Exchange Rules
A 1031 exchange is an Internal Revenue Code tax rule that allows taxpayers to defer indefinitely capital gain and recaptured depreciation taxes when selling and replacing with like-kind real or personal property held for productive use in a trade, business or for investment. The tax deferral requires strict adherence to the 1031 tax exchange rules to effectively postpone the tax payment until the replacement property is sold or possibly eliminated if heirs sell, when received or minimized when selling a primary residence that was previously a replacement rental property in a 1031 exchange.
1031 Exchange Examples
1031 exchange examples include any real property exchanged for like-kind real property. A 1031 exchange is a tax deferral strategy based on the Internal Revenue Service and Treasury Department Regulation Code Section 1031. The 1031 code states “No gain or loss 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.”
No Gain or Loss
When real property is sold, federal and state capital gain and recaptured depreciation taxes are triggered that can exceed 40 percent of the sales price. If the taxpayer’s intent is to replace the property sold with like-kind property of equal or greater value or even partial value, within 180 calendar days of the initial sale, then the 40 percent tax obligation can be deferred indefinitely or until the replacement property is sold. There is no limit to the number of 1031 exchanges a taxpayer can initiate.
In effect, the 1031 exchange is an interest free loan. The taxpayer is able to use those otherwise paid tax dollars towards acquiring replacement property.
1031 Exchange Examples
Real property can also be exchanged and taxes deferred. Commercial property such as rental properties, condominiums, buildings, shopping centers, strip malls, timberland, mineral, gas and water interests (state dependent) and land represent real property eligible for a 1031 exchange. Real property with predominant use in the US can be exchanged with real in the US. Property held overseas can be exchanged for property held internationally. A taxpayer who owns a condominium held for investment in Singapore can exchange for real property held in a trade, business or for investment in India.
Improvement or Build to Suit Exchanges
1031 exchanges also include improvements made to real property such as when a taxpayer who sells a condominium or rental property acquires a rental property that requires improvements or rehab. In a 1031 exchange, the replacement property is titled to an Exchange Accommodator Titleholder while the improvements are made to the property. The real property is conveyed to the taxpayer no later than the 180th calendar day posting closing on the old property.
Examples of 1031 exchanges are everywhere, from gas stations and convenience stores to motels, land, condominiums, apartments and equipment. To view specific 1031 exchange examples view the Atlas 1031 testimonials. To download an eBook on “Ten Reasons Why a 1031 Exchange Makes Sense,” click here.