Let’s face it, tax codes are rarely going to be an easy subject for the vast majority of us to understand. In fact, most homeowners would rather watch paint dry than discuss the finer points of tax law. But for many Utah residents with property to sell, there’s may be one particular exception: A section 1031 exchange of like-kind property.
A 1031 (or “like-kind”) exchange has entered popular discussion, particularly as homeowners are becoming increasingly concerned about the potential tax implications of selling their homes. And with good reason, Capital gains tax from the sale of property has been known to be as high as 20 percent in many cases.
The average Utah home sale in 2019 was roughly $325,000. That’s $65,000 in taxes. $65,000 you could have saved.
But before you consider a 1031 property exchange as a potential solution for capital gains tax, let’s examine what it is first; as well as why you should and more importantly when you shouldn’t.
What Is A 1031 Exchange?
A 1031 exchange occurs when one property is exchanged for another of equal value. It was at one time almost exclusively the domain of commercial real estate holders, but has since become popular among homeowners looking for a convenient way of avoiding tax penalties as a result of a property sales gain.
More specifically, the advantage of a 1031 property exchange is the result of the tax basis of the former property being transferred to the new one. As long as there isn’t any real profit made, it’s considered a capital gains loss. What does that mean for homeowners?
No actual taxes are due. In fact, your investments can continue to grow—entirely tax-deferred. In theory, you could roll over the tax basis from property to property. There’s no actual limit on how many times or how frequently you can perform a 1031 property exchange.
Almost no limits.
What Are The Rules Of A 1031 Exchange?
- Federal law requires you within 45 days after the sale of one property to identify another of equal value in order for it to qualify as a 1031 property exchange.
- Final closing of the purchase of any replacement property must be made within 180 days after the sale of your property.
- If property is exchanged for property of a lesser value during a 1031 property exchange, it’s considered a capital gain—meaning it’s subject to the original 15 to 20 percent capital gains tax you were hoping to avoid. Any cash left over after purchasing a replacement property is subject to tax.
What To Consider About A 1031 Exchange
- Do: A ‘delayed’ exchange through a third party intermediary who will hold the cash for you and use it to purchase the swapped property.
- Don’t: Accept the payment yourself. It would automatically make the purchase a taxable exchange and hold you liable for a capital gains tax.
- Do: Complete the purchase only after you sell.
- Don’t: Use your own CPA, attorney or financial planner as an intermediary. IRS law dictates no 1031 exchange can be completed using a third party you have a personal or professional relationship with.
- Do: Consider using rental properties or vacation homes during a 1031 property exchange.
- Don’t: Use your primary residence. It’s not considered a business investment and subsequently not subject to capital gains tax unless it’s sold for greater than fair market value.
- Do: Consider exchanging residential for commercial space and vice versa so long as it is of equal value.
- Don’t: Exchange property which still has debt attached for a smaller liability. Any difference is subject to both tax and creditor payments.
- Do: Document your intention of conducting a 1031 exchange in your purchase & sale agreement. It’s legally required under federal tax law.
- Don’t: Reinvest proceeds in property you currently own or may have previously owned.
- Do: Invest in property in the US or US Virgin Islands only. Foreign investments do not qualify.
- Don’t: File that year’s income taxes until after the 1031 exchange occurs.
What If The Value Of My Property Has Actually Decreased?
If the value of your property has actually depreciated since your initial investment, it’s likely claimable as a tax loss; meaning you could actually stand to profit from its sale without paying a capital gains tax.
At Gary Buys Houses, we help homeowners find a convenient solution by purchasing depreciated secondary properties as is; sometimes in as little as 3 to 5 business days. We can give you a fair estimate on your secondary property that could potentially allow you to claim it as a tax loss and still make money in the process.
Keep in mind that every situation is entirely unique and tax laws are complex. Please contact a trusted tax specialist if you have any specific questions.