1031 Exchanges
Will President Trump repeal 1031 exchanges? Rumors abounded that President Obama would do just that. It never happened. We have seen the outlines of the Trump tax cut, and it doesn’t appear that laws for 1031 exchanges will change.
This just in from The Real Deal: 1031 lives!
There’s been plenty of anxiety over 1031 exchanges, which allow property owners to avoid taxes on profits from property sales if they reinvest them into real estate. In June, the Wall Street Journal reported that some lawmakers wanted to get rid of the benefit. For now, they lost out. The GOP tax plan keeps 1031 exchanges for real estate in place. As a bonus, it would also repeal the estate tax.
What are 1031 Exchanges?
Under current law, an exchange of property, like a sale, generally is a taxable transaction. If you sell a business or farm, taxes will be due on the gain from your basis (your cost). 1031 exchanges are a special rule that provides that no gain or loss is recognized if you exchange property for a like-kind property. “Like-kind” property is pretty broad. Currently, you can continue exchanging one property for another and not pay any capital gain taxes.
1031 exchanges do not apply, however, to exchanges of stock in trade or other property held primarily for sale, stocks, bonds, partnership interests, certificates of trust or beneficial interest, other securities, etc. They do not apply to your primary residence.
A like-kind exchange does not require that the exchange of properties happens simultaneously. As long you identify the property received in the exchange within 45 days and ultimately received within 180 days of the sale of the original property, you can defer the tax.
7 Key Rules About 1031 Exchanges
Robert Wood writing in Forbes about 7 Key Rules About 1031 Exchanges says, “There’s no limit on how many times you can do a 1031 exchange. You can roll over the gain from one piece of investment real estate to another, then another and another. You may have a profit on each swap, but you avoid tax until you actually sell for cash.” But, he cautions, be careful and do it right. Doing it right means to Wood:
- Investment, Not Personal. 1031 is for investment and business property, not personal.
- Like-kind is Broad.
- Delayed Exchanges are OK.
- Designating Replacement Property. There are two timing rules you must observe for a delayed exchange.
- Close Within Six Months.
- Cash Taxed. Cash left over? The intermediary pays it to you at the end of the 180 days. That cash or “boot” gets taxed, generally as a capital gain.
- Beware Mortgages. You must consider mortgage loans or other debt on the property you relinquish, and any debt on the replacement property you acquire. If you don’t receive cash back, but your liability goes down, that too will be treated as income just like cash.
There are some pitfalls to 1031 exchanges:
- Substantial fees in the transfer (agents, lawyers—yes, even accountants) can reduce the expected benefits making the transaction unprofitable.
- Often you must pay substantial premiums to attract sellers of property to engage in 1031 exchanges.
- Current tax rates are at historical lows (particularly capital gains at 15 percent). The rates are likely to increase in the future and could greatly reduce expected benefits.
- 1031 exchanges can and do fail, which can result in costly litigation. After all, a 1031 involves two properties, which doubles the potential deal killers.
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