President Trump signed into law the Tax Cut and Jobs Act taking effect January 1, 2018, changing the 1031 tax deferred exchanges that were first imposed in 1921. The major change to the 1031 code is the removal of tax deferral treatment for tangible and intangible personal property, including assets such as collectible cars, aircraft, gold and silver bullion, equipment, cars and trucks, franchise fees and licenses. Tax deferred exchanges for real property were maintained.
1031 Tax Code
Tax deferred exchanges allow the taxpayer, whether an individual, husband and wife, partner, trust, limited liability company, corporation or partnership, to defer the federal and state capital gain and recaptured depreciation taxes when property held in the productive use of a business or investment is replaced with real property held in the productive use of a business or investment. The tax deferral can reflect upwards of forty percent of the sales price in high state capital gains tax states, such as California and New York. Any type of real property, excluding a primary residence, second home or land, with a fact pattern of and itemized as an investment property taking depreciation is eligible for the tax deferral to those taxpayers subject to federal income tax, including non-resident aliens.
1031 Exchange Basics
There are many rules that must be followed to defer the gain in a 1031 exchange. A Qualified Intermediary (QI) must be used to hold the exchange funds in a manner that preserves principle and liquidity and to create 1031 exchange agreements written in accordance with the Internal Revenue Code Section 1031. The QI cannot be a disqualified party, including a person or entity that the taxpayer has engaged in the last two years, or be in the lineal ascending and descending blood line of the QI, such as a parent, sibling or child. The exception to the rule is an attorney engaged only in the closing stage, or a banker. If the transaction is two party—meaning the taxpayer wants to acquire the Buyer’s property and the Buyer wants to acquire the Seller’s or taxpayer’s property—then a QI is not required.
To defer one hundred percent of the gain, the replacement property must be greater than the relinquished net sales price. The gross selling price less the sales commission, title, governmental transfer taxes and QI fees equals the net sales price. If the replacement property is less than the net sales price, then a tax is triggered on the difference.
The taxpayer who is on the relinquished property deed must be the taxpayer on the replacement property deed. One exception to this rule is if the taxpayer is an individual, then the replacement property can be acquired as a single member limited liability company, given the sole member is the individual. If the relinquished taxpayer is the wife and the husband will be on the replacement property loan, the lender will most likely require the husband also be on the replacement property deed.
If the relinquished property is a dwelling unit, Revenue Procedure 2008-16 must be followed, requiring that the property to be sold is held for at least two years and in each of those two years, the property must be rented at least fourteen overnights and had no more than fourteen overnights of personal use. The replacement dwelling unit must also follow the same rental and personal use requirement.
1031 exchanges have two primary time thresholds, the forty-five day identification requirement and exchange completion within 180 calendar days from the initial exchange closing. Up to three properties, regardless of value, or four or more properties given the aggregate purchase price does not exceed two hundred percent of the relinquished property sale price, can be identified to the QI by property address no later than 11:59 PM on the forty-fifth calendar day.
1031 exchanges are not eligible for:
- Primary Residence
- Indebtedness, notes or mortgages
- Stocks, bonds and securities
- Partnership interests
- Inventory
Orlando, Florida New Branch Office
Effective February 5, 2018, my son, Tom Gustafson, joined Atlas 1031 Exchange, LLC as Manager to listen, respond and accommodate the 1031 needs of taxpayers, Realtors, Title Companies, CPAs, Financial Planners and Attorneys in Central Florida. Tom’s office is in Orlando, Florida and I am excited to have his maturity and professionalism join the Atlas 1031 Exchange staff.
