like-kind

Three 1031 Exchange Myths

Posted on | by Tom Gustafson | Leave a Comment on Three 1031 Exchange Myths

Over the years while speaking at seminars and in phone consults, three common 1031 exchange myths appear. Prior to getting to the three myths, let’s cover “what is a 1031 exchange?”

1031 Exchange

A 1031 exchange allows the seller of a rental property to sell and defer the capital gains and recaptured depreciation taxes as long as any type of real property such as land, oil and gas royalties, or commercial property are acquired of equal or greater value. Tangible and intangible personal property such as livestock, aircraft and patents are also eligible for 1031 tax deferral treatment.

The tax obligation does not evaporate, but rather delayed, postponed until the replacement property is sold. The tax can represents up to 40% of the old property’s sale price. Why not use those dollars towards purchasing the replacement property?

1031 Exchange Myths

The top three exchange myths are:

  • land must be exchange for land or rental for rental property.

As with all 1031 exchanges, consideration must be given to the nature and character of conveyed rights of the 1031 exchange properties to determine whether they are essentially alike. This includes the likeness of physical properties, character of title conveyed, rights of the parties and period or duration of interests. Real property can be exchanged for any real property.

  • Earnest money deposit can be returned at propert closing tax free.

The IRS views the first dollar out as taxable. Yes, that means being taxed twice.

  • Replacing retired debt from first closing is not required.

Many assume only the net equity from the sale needs to be reinvested. If the old property has debt, then that debt must be replaced in the replacement property, unless additional cash takes its place. Cash offsets debt, but debt does not offset cash. If the debt is not replaced, a tax is triggered called mortgage boot or a benefit of no longer having the debt.

Conclusion

There are many 1031 exchange rules. Engage a qualified intermediary that will ask the appropriate questions to help make sure you are aware of your responsibilities.

Do you have a question regarding a 1031 exchange? I always suggest to engage the qualified intermediary when you are considering placing the property up for sale. Experience matters.

1031 Tax Consequences of Selling Business Assets

Posted on | by Andy Gustafson | Leave a Comment on 1031 Tax Consequences of Selling Business Assets

When selling a business, consideration of the tax consequences, including a 1031 exchange is often not at the top of the list. Following a meeting with your CFO or CPA, the federal, state and recaptured depreciation tax obligation is determined and now included in the dizzying array of outcomes as is the decision of whether or not to replace the assets. By replacing all or some of the assets, the federal, state and recaptured depreciation taxes can be deferred in a 1031 exchange. Rather than paying the tax, those dollars can be used towards as an interest free loan towards acquiring replacement property. The tax obligation does not go away, but is postponed; delayed until time the newly acquired property is sold. Another 1031 exchange is possible, or should the assets be inherited, the basis is stepped up to the heirs.

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Like-Kind Exchange Insight

Posted on | by Andy Gustafson | Leave a Comment on Like-Kind Exchange Insight

Like-Kind ExchangeThe term “like-kind exchange” describes the federal and state capital gains tax deferral strategy requirement of an Internal Revenue Code (IRC) Section 1031 tax deferred exchange that properties exchanged must be like-kind to one another. A 1031 exchange effectively defers the gain triggered by the sale that can represent upwards of 40 percent of the property’s sales price. The like-kind exchange represents an indefinite, interest free loan that is due when the replacement property is sold, unless the basis is stepped up to the taxpayer’s heirs or another like-kind exchange is initiated.

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Like-Kind: 1031 Exchange Definition and Application

Posted on | by Andy Gustafson | Leave a Comment on Like-Kind: 1031 Exchange Definition and Application

For those not familiar with 1031 exchanges, the definition and application of like-kind requires an explanation to fully appreciate the breadth and depth. 1031 like-kind exchanges were first legislated as part of the National Revenue Act of 1921. 1031 exchanges were created under the premise that when a taxpayer reinvests the sale proceeds into another like-kind property, the economic gain has not been realized (creating the funds to pay the capital gains tax). The taxpayer’s economic position is the same, only the property has changed, as in land for an investment rental property. Consequently, to pay the tax when the replacement property of equal or greater value is acquired is unfair. Rather, when the replacement property is sold, the deferred gain from the original property plus any additional gain realized since the purchase of the replacement property is subject to tax. If another 1031 exchange is initiated, the tax is deferred.

Like-Kind Property Definition

The 1031 exchange code states that 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. Property held in the United States is considered like-kind with property held in the United States, while property held internationally is like-kind with property held internationally.

State laws also determine whether a property is considered real or personal as is the case of water rights and options. Does the state consider mobile homes in a mobile home park personal or real property?

Like-Kind Application

In a 1031 exchange, the real property application is broad, allowing real property to be exchanged for any real property. Real property exchanges consider factors including “the respective interests in the physical properties, the nature of the title conveyed, the rights of the parties, and the duration of the interests” per Koch v. Commissioner of Internal Revenue, 1978. Examples of real property exchanges include:

  • Land for an apartment building
  • 30 year leasehold interest for timberland
  • Single family rental for percentage interest in a Delaware Statutory Trust
  • Improved real estate for unimproved real estate

What is not eligible for 1031 consideration is:

  • Primary residence
  • Partnership interests
  • Stocks, bonds or securities
  • Debt
  • Inventory

Understanding what property is eligible for a 1031 exchange is one of the first steps to understanding the value of 1031 exchanges. For a complimentary eBook on “Ten Reasons Why a 1031 Makes Sense,” click here to receive your copy instantaneously.