In the general course of business, a taxpayer who sells an asset may be subject to the payment of capital gains taxes on the gain realized from the sale of the property. Section 1031 of the Internal Revenue Code, however, offers another option – an exchange instead of a traditional sale. When a taxpayer successfully utilizes Section 1031, the capital gains tax that would otherwise be due under a traditional sale is deferred. An example of a straightforward 1031 Exchange would be a taxpayer who relinquishes a piece of rental property and then acquires another similar property that will also be used as a rental. A Qualified Intermediary, or QI, must facilitate 1031 Exchange transactions in order for a taxpayer to benefit from the exchange. Some potential exchanges are considerably more complicated than the previous example; however, even these transactions can potentially qualify for Section 1031 Exchange treatment. Certain types of transactions, for instance, may be eligible for the “Like Kind Exchange Program”, or LKE Program.
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8824 IRS Form Like-Kind Exchange
Internal Revenue Service (IRS) Form 8824 is used by the individual, corporate, resident and non-resident taxpayer to report their 1031 like-kind exchange. A 1031 like-kind exchange is a tax strategy that allows the taxpayer to defer indefinitely the federal and state capital gain tax triggered by the sale of real property held for productive use in a trade, business or for investment when replaced with like-kind property within 180 calendar days of the initial transaction. In exchanges of US real estate, a 1099 is generated by the closing company with a copy forwarded to the IRS and to the taxpayer. It is the responsibility of the taxpayer to itemize the 1031 exchange when filing their federal tax return to report the exchange proceeds were used towards the acquisition of replacement property in a like-kind exchange.
Form 8824
The four part form 8824 asks a series of questions including descriptions of the property sold and acquired, the 45th calendar day the replacement property was identified and received, related party, realized and recognized gain and basis of like-kind property received. The first three parts are typically completed while part four is to be completed by officers or employees of the executive branch of the federal government.
The related party questions are looking for those 1031 exchanges where a related party was involved in purchasing or selling their property to the taxpayer. A related party is a grandparent, parent, child, sibling, trust or entity where the taxpayer owns fifty percent or more. In-laws are not considered a related party. Should the related party who acquired the old property from the taxpayer sell the property within two years of the 1031 exchange, the tax deferred in the 1031 exchange is triggered.
The qualified intermediary who accommodated the 1031 exchange is to be identified, including their tax identification number, per question seven and nine.
If multiple exchanges are completed, the IRS instructs filers to include a summary page along with responses to form 8824 for each exchange. The 8824 forms are filed in the year the relinquished property title is conveyed.
IRS Form 8824 Reporting
Reverse 1031 Exchange
In a reverse 1031 exchange, when the replacement property is acquired before the sale of the old property, there is a parking arrangement known as a Qualified Exchange Accommodation Agreement with the Exchange Accommodation Titleholder or EAT and a simultaneous exchange agreement. The simultaneous exchange agreement is completed in the first leg when the EAT receives title to the old property before the new property is acquired by the taxpayer, or in the second leg when the old property is sold and the replacement property title is conveyed from the EAT to the taxpayer.
In an exchange last where the replacement property is parked with the EAT, the date used is when the taxpayer conveys the relinquished property title to the buyer and the EAT conveys the replacement property title to the taxpayer. In an exchange first, the date used to answer question four is when the relinquished property title is conveyed to the EAT and the taxpayer acquires the replacement property from the seller. Typically, the date the title is conveyed to the EAT is the same day as the replacement or relinquished property found on the settlement statement.
Forward 1031 Exchange
In a forward 1031 exchange, the relinquished property is sold prior to acquiring the replacement property. The date to use in question four is when the relinquished property title was conveyed. Question six asks the date the replacement property was received or the date found on the replacement property settlement statement.
The IRS provides a publication that discusses each question on Form 8824.
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Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
Three Reasons to 1031 Exchange Gold and Silver
The 1031 exchange is found in Section 1.1031 of the Internal Revenue Code. The 1031 exchange allows taxpayers to defer the federal and state capital gains tax when exchanging property held in the productive use of a trade, business or investment. Property can be either real or personal property including collectibles or precious metals such as gold and silver. In a precious metals exchange there are many rules to follow, so it is best to either research the requirements or contact a qualified intermediary who accommodates gold and silver 1031 exchanges to discuss your specifics.
1031 Exchange and Stepped Up Basis
In a 1031 exchange, federal and state capital gains and recaptured depreciation taxes are deferred when real property held for use in a business or for investment is sold and replaced with like-kind real property. There are many rules to follow with one of those being that the exchange must be completed within 180 calendar days.
1031 Exchange
There are many reasons why a 1031 exchange makes sense. It could be that the taxpayer, who can be an individual, trust, partnership or corporation, uses the following in their business:
- farmland
- commercial building
- a vacation rental property
to be replaced with more efficient properties that can provide greater cash flow or depreciation to offset income. Perhaps the taxpayers have moved to be closer to their families and now want their investment properties to be close by to oversee. Land is sold and replaced with a property that provides a cash flow. Commercial properties are sold and replaced with properties in the path of progress to benefit from the anticipated appreciation in value.
The 1031 exchange provides the mechanism to easily replace assets with another without having to pay the immediate tax consequences. In effect, an interest free loan is the outcome for use towards acquiring the replacement property.
Stepped Up Basis Impact
When a taxpayer dies, their property can be given to their heirs. The property may initially go into an estate where taxes are imposed based on federal tax laws. The American Taxpayer Relief Act effective January 2, 2013 affected changes to estate taxes that should be reviewed with appropriate counsel. Where property is passed on to the heirs or beneficiaries, the receiving taxpayers take ownership of the property at comparable market prices. Comparable properties prices are determined by a market analysis of what other properties with similar characteristics have sold. The comparable market price represents the price or basis the heirs receive the property. Their tax basis is not the price their decedents paid for the property, rather the property value is stepped up to the date of their death.
The stepped up basis impact on 1031 exchanges is huge. If the property is sold soon after the property is received, there is no appreciation or depreciation. Consequently, there is no gain, tax due or need to initiate a 1031 exchange. If the property is held for a couple of years after the property passes to the heirs, then the capital gains tax needs to be determined. Given the current market as of the date of this article, there may a good chance the property has not appreciated to the point where a sizable tax is generated.
Determining the Recognized Gain or Capital Gains Tax
To determine the tax consequences, the first step is to take the comparable market price which represents the original price plus improvements less depreciation taken. This equals the adjusted basis. Next, the sales price for the property less the adjusted basis less the selling expenses, such as realtor commissions and title fees, equals the realized gain. Depending upon the taxpayer’s income bracket and state capital gains tax rate, the tax is determined by subtracting the depreciation taken (by the current taxpayer) from the realized gain and multiplying by 25 percent. This represents the recaptured depreciation if depreciation was taken on the current taxpayer’s tax return. The federal, state and possibly county capital gains taxes are applied to the remaining balance to determine the recognized gain or tax due.
Once the tax is determined, a decision can be made to whether initiate a 1031 exchange or pay the tax and avoid having to replace the property.
If you have received primarily real estate from a decedent and are considering selling the asset, seek the counsel of your CPA to understand the tax consequences.
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1031 Exchange Rules Maine
According to the rules of the Internal Revenue Service, a taxpayer is required to pay capital gains taxes on the gain realized from the sale of real and personal property unless an exception to the general rule applies. Capital gains taxes can quickly diminish any profit realized from the sale of a property. For this reason, taxpayers often choose to enter into a Section 1031 Exchange instead of a traditional sale when this option is available. If a transaction qualifies for Section 1031 Exchange treatment, any capital gains tax obligation that would otherwise be due is deferred. Along with the federal requirements for Section 1031 treatment, some states have enacted legislation that applies to these transactions as well. In Maine, for example, Chapter 212C of the Maine Revised Statutes covers the applicable rules for anyone who acts as an exchange facilitator for a 1031 Exchange in the state.
2013 Capital Gain Tax Increase and Impact on 1031 Exchanges
Capital gain and 1031 exchanges are as intrinsically related as are the terms cause and effect. The amount of capital gain is the cause and the deferral of the gain in an Internal Revenue Code (IRC) Section 1031 tax deferred exchange is the effect. As the capital gain increases, the value of the deferred tax also increases. The American Taxpayer Relief Act of 2012 permanently increased the Federal long term capital gain rate for top income earners (Modified Adjusted Gross Income of $400,001 + for individuals and $450,001 + for married filing jointly) from 15 percent to 23.8 percent including the IRC Section 1411 3.8 percent Medicare Surtax. Consequently, high income taxpayers who plan to replace the disposed asset within 180 calendar days with a like-kind asset have the incentive with a 1031 exchange to indefinitely defer the capital gains tax on real and personal property held in a business or for investment. By deferring the gain, those otherwise paid out dollars are used towards the replacement property purchase, interest free.