Despite all the literature and discussion regarding 1031 exchanges, landlords can defer (or potentially avoid altogether) capital gains taxes on the sale of their property by following these six basic rules:
1. Sell and Buy Bona Fide Rental Property
Don’t try to get cute with an exchange. 1031 exchanges are reserved for people who own legitimate business or rental property. This does not include second homes or flipped houses. And Section 1031 no longer applies to equipment or livestock —again, it’s just for business or investment real estate. Yet all real estate sectors are “like kind” with each other, so a property investor can sell their apartment building and replace it with any other type of property, as an example.
- Buy at Least as Much Property as was Sold
In other words, “Always trade up.” If a relinquished property sold for $1 million, it must be replaced with $1 million of investment property. Even if the loans were paid off, the entire value still needs to be replaced. To achieve this, an investor has three choices: 1) use all cash to buy the new property; 2) obtain a new loan to replace the old loan; or 3) invest in a 1031 program with built-in financing. The prior loan can be replaced with cash or debt, but the equity cannot be replaced with additional debt.
- Use a Qualified Intermediary to Safeguard Your Exchange Funds
Under 1031 rules, and investor must have a “qualified intermediary” (“QI”) also known as an “exchange accommodator”, receive and disburse the exchange funds. This special escrow must be arranged before an investor sells their relinquished property; if the investor touches the money from the sale, The exchange may no longer hold the same tax benefits. When and investor opens escrow on their investment property sale, they can simply call a QI firm and the QI will handle all the details.
- Follow the Deadlines
In a 1031 exchange, the investor must identify a replacement property or properties within 45 days of closing your sale. After the 45-day identification deadline, the investor can only purchase one or more properties listed on their “ID Letter”, which they provide to their QI. The ID Letter can have up to three properties of any value OR any number of properties whose combined value does not exceed the value of the relinquished property. After the 45-deadline, the investor has an additional 135 days (180 days from the sale of the relinquished property) to complete the purchase transaction. There are no exceptions for these deadlines.
- Don’t Change Ownership During Your Exchange
The Investor should not use a 1031 exchange as an opportunity to dissolve a partnership or LLC. Generally, the entity selling a property should be the same entity acquiring the replacement.
- Swap ‘til You Drop
Under current tax law dating back decades, the cost basis of real estate is “stepped up” when the property owner passes away (rules for married couples vary depending on the state). This means heirs may be able to sell inherited real estate upon the owner’s death without incurring any capital-gains tax. By completing successive 1031 exchanges over the a lifetime, an investor’s heirs may be able to avoid the growing tax bill that would otherwise be due if the property was liquidated prior to the owner’s passing.
Information for this piece was found through IRS Section code 1031
This is for informational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Such offers are only made through the sponsors Private Placement Memorandum (PPM) which is solely available to accredited investors and accredited entities.
This is for informational purposes only and there are material risks associated with investing in real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.
IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax concepts; therefore you should consult your legal or tax professional regarding the specifics of your particular situation.
Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA) 1031 Capital Solutions is independent of CIS, CAM and CIA.