1031 exchange

Three Easy Steps to Tax Deferred Formula

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Capital gains and recaptured depreciation can be determined in three easy steps.  If you are considering a 1031 exchange, the taxes due represent the value of the 1031 exchange or what the IRS will consider deferred if equal or greater replacement property is acquired. It could be considered an interest free loan because the gain is not paid to the IRS but used towards the replacement property.

Step Number One

The first step is adding three numbers together to determine the adjusted basis.

Original purchase price + capital improvements – depreciation taken = adjusted basis

Step Number Two

Sales price – adj basis – selling expenses = realized gain

Step Number Three

Recaptured depreciation (depreciation taken * 25%) =

Federal capital gain (Realized gain – depreciation) * 15% =

State capital gain (Realized gain – depreciation) * __% if applicable =

Add these numbers together and you have determined the tax due. If you initiate a 1031 exchange, this value is deferred gain until the replacement property is sold. Another 1031 exchange can be used to defer the gain and recaptured on the replacement property, exchanging as many times as needed.  There is no limit to the number of times you can use a 1031 exchange.

Conclusion

Now that the tax triggered by the sale is known, be sure the the net equity and retired debt (if any) on the old or relinquished property will be equal to or greater in the replacement property.  If you want to pull out cash tax free, consider a post exchange refinance once the replacement property closes. If you remove cash at the closing of the old property it will be taxable.

The next step is to confirm your numbers with your accountant and decide to initiate a 1031 exchange.

Deductible and Non Deductible Selling Expenses in a 1031

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Deductible Selling ExpensesWhat selling expenses in a real estate transaction are not taxable if paid from the 1031 exchange proceeds? Specifically, in a 1031 exchange, what selling expenses can be paid from exchange proceeds without triggering a tax?

Deductible Selling Expenses

Selling expenses that are not taxable typically include:

  • Commissions
  • Finder’s fees
  • Title charges
  • Title search fees
  • Title examination
  • Notary fees
  • Title insurance
  • Document Prep
  • Courier fees
  • Escrow fees
  • Tax certification
  • Pest inspection
  • Testing fees
  • Survey
  • Gov’t recording
  • Home warranty
  • Legal and 1031 fees
  •  QI fees

Minor repairs required for the sale can be paid from exchange proceeds directly to the contractor.

Non Deductible Selling Expenses

Selling expenses that should be taxable as ordinary income include:

  • proration of rents;
  • property taxes;
  • property insurance premiums debited against the Exchangor;
  • reserves deposited with the lender and utilities;
  • any items payable in connection with a loan are considered taxable.

Reimbursement for major repairs, capital improvements and earnest money deposits are considered taxable. The Service views the first dollar paid out as taxable. In a 1031 exchange if you need to pull these funds out, a post exchange refinance is an alternative. After the replacement property has closed, secure a line of credit on the property. You can then pull out cash without triggering a tax.

Another alternative is to do a partial exchange, recognizing that any cash received is taxable. There is a point when the equity pulled approaches 50% that it does not make sense to initiate a 1031 exchange. Always seek the counsel of your accountant for tax planning strategies like 1031 exchanges.

 

Commercial Property 1031 Exchange

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This 1031 exchange was for two commercial properties with closings four days apart. The commercial broker called to introduce the client stating the turn around on the replacement property will be quick. In 1031 exchanges with property closings within five calendar days of each other, escrow instructions will request the “net equity” be wired from one closing to the next without going through an escrow or bank account. A formal property identification was not required because the replacement property was acquired within the first forty five days post closing on the relinquished property. The commercial property exchange went smoothly and the capital gain was successfully deferred.

Testimonial

“The 1031 exchange was a win-win. The value of the service was excellent from the initial contact to the final exchange interview. Andy knows what he is doing and has my full confidence to handle our client’s 1031 exchange requirements. He stays current on 1031 tax law changes. Marian McBryde, the Closing Manager at the Dowd Law Firm for this transaction also remarked how easy it is to work with Andy and refers him to their clients. Andy is the go to guy for 1031 exchanges.”

Craig Barrett
CEO
NBI Properties, Inc.
Fort Walton Beach, Florida

 

CPA Response to 1031 Exchange

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At the completion of each 1031 exchange, a summary file is forwarded to the Exchangor and designated CPA if requested. The intent is to provide executed 1031 exchange documents including settlement statements and property identification letter to assist with the completion of Internal Revenue Service Form 8824 used to itemize the 1031 exchange details. It is a value add service provided over the years, verifying the intent and facts supporting the intent to affect a 1031 exchange in accordance with the Internal Revenue Service Code 1.1031 exchange rules.

Testimonial

Here is an email received from an Exchangor’s CPA:

“Andy,

I see you are also working late; thank you for such a prompt response.

I have prepared returns for 35 years and have reported numerous 1031 Exchange transactions and have worked with a variety of qualified intermediaries, but I must admit that I don’t recall ever working with one as thorough and helpful as you have been. I would definitely not hesitate to refer someone to you when the occasion arises.

Thanks again,

Allen”

C. Allen Anderson & Associates, P.C.
C. Allen Anderson, CPA
Franklin, Indiana

 

Ask The 1031 Expert Response Quality

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Michael submitted a question through the Ask The 1031 Expert feature on the Atlas 1031 web site. The question centered upon whether the sale of rental property owned in Australia could defer capital gains in a 1031 exchange by purchasing replacement property in the United States. The Omnibus Budget Reconciliation Act of 1989 added subsection (h)(1) of Section 1031 stating that real property located in the United States and real property located outside the United State are not property of like kind.

Within six minutes of submitting the question, our Certified Exchange Specialist® called Michael to listen and respond to his questions. An estimated capital gain tax was calculated along with a suggestion to confirm with his CPA whether Australian capital gains will offset US capital gains.

Testimonial

“Andy, you and your firm are awesome. I did not expect that somebody would call me and explain 1031 exchanges in the detail and that is without any charge. I really appreciate your help and guidance. In the future, if I need the service, you will be the first person I will call and I will not hesitate to refer you to any of my friends and family. Thanks once again.”

Michael Patel
Raleigh, North Carolina

 

FIRPTA Forward 1031 Exchange

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A title company I have known and facilitated 1031 exchanges for over the years in the Florida Panhandle called to introduce one of their clients. Karen’s 1031 forward exchange was a bit unique in that she is a resident of New Zealand requiring additional Internal Revenue Service filings. The forward 1031 exchange accommodated a vacation rental property in the Florida Panhandle and acquired an investment property in Hawaii within the 180 calendar day requirement.

Foreign Investment in Real Property Act of 1980

Her CPA contacted me to assist in completing Form 8288. Every nonresident alien selling real estate must comply with the Foreign Investment in Real Property Tax Act (FIRPTA) requiring 10% of the selling price withheld and submitted to the IRS. We completed the form, submitted to the IRS in Philadelphia requesting a withholding certificate and was not required to submit the 10% which in Karen’s transaction would have represented a sizable figure. Karen chose to work with two banking service providers splitting the funds between two escrow accounts, one requiring a personal identification number and a qualified escrow account requiring dual signatures to authorize the disbursement of exchange funds. When she purchased her replacement property in Hawaii, funds were wired a couple of days in advance of the closing and the 1031 exchange was completed.

Testimonial

“You did make it easy and clear … you were the only one in the process that didn’t create a drama, ha!”

Karen Sandler, Auckland, New Zealand