Top 4 1031 Exchange Considerations

A 1031 exchange of real estate is popular mainly in investment circles but also among some homeowners because it allows you to avoid a taxable sale. The Internal Revenue Service (IRS) will not tax you on capital gains if all the rules and requirements are met for a legitimate 1031 exchange. If it was a perfect opportunity, many property owners would exchange property more often. Many don't, because there are some 1031 exchange considerations to keep in mind.

Inflexible Time Lines

The property that you transfer in a 1031 exchange is called the “relinquished property.” What you get in return is referred to as the “replacement property.” Once someone identifies your relinquished property, he has as many as 180 days to close. That’s a lengthy time line for a deal that may not actually close, and selling the property outright may be a better choice.  It depends on your personal circumstances and your financial situation. Not having to pay federal taxes is often worth the wait, but once you commit to a 1031 exchange, you basically lock yourself in to that type of deal.

Opportunities May or May Not Be Attractive

The main rule for a 1031 exchange is that the relinquished and replacement properties must be “like-kind.” For example, a multi-family unit building would be exchanged for another multi-family unit building and not a single-family home.  According to the IRS, property in the United States and property located elsewhere is not considered like-kind property. Whether the available opportunities are attractive depends on the property you own, because that’s the class of properties you’ll be restricted to. You have to pay attention to what’s going on in the market concerning the class of property you want to exchange.  For example, if the prices of multi-family unit buildings continue to drop and have been doing so for a while, you may be better off selling and buying another kind of property as an investment or to live in.

Capital Growth

If the equity in your home has increased over the years, and if the exchange would result in a higher equity amount in your property, then you’ll want to do what you can to protect the resulting capital growth. The way you do that is to shield the capital growth from taxes, which is the aim of the 1031 exchange. A traditional sale would lower your capital growth, because the sale would be taxable, which means you would owe taxes on the capital gains. If you’re not sure how to figure out what the capital growth would be in the exchange and the taxes involved, ask a certified public accountant who has experience with these exchanges.

Part Sale and Part Exchange

When the replacement property is worth more than the relinquished property, you can still do a 1031 exchange. To defer all of your taxes, you would have to use the proceeds from the sale to purchase new property. The taxes owed would be the lesser of the difference between the exchange amount and sale price or the full capital gains.

Get the help of an accountant and real estate lawyer if you plan to do a 1031 exchange. You don’t want to make a mistake and end up owing the very taxes you’re trying to avoid.

blog comments powered by Disqus