1031 Exchange

For Investors.
Consider the use of this tax code, on your next “Investment Property” Transaction.
Internal Revenue Code Section 1031:
Tax Deferred Exchanges

Disclaimer: I am not giving advice on Taxation or Financial Planning. I am not an Accountant or CPA, Tax Lawyer, or Financial Advisor. All the content on this web page should be discussed with professionals in their perspective fields of Taxation and Financial Aspects.

An Exchange can be structured in a number of ways. You should have a Tax and Financial advisor assist you.

My Role: Finding solutions for Buyers and Sellers that meet their specific needs, it's not an easy task. Also, to have an Understanding of Contracts and the Execution of the RPA, is crucial. The Residential Purchase Agreement is very detailed and filled with many deal breaking scenarios. It also creates a significant amount of information for the buyer to understand and appreciate the property. There are Conditions, Contingencies, Deadlines, Forfeitures, Exit Scenarios, Good Faith Measures and Negotiations, just to name a few. There are about 40 disclosures to review, in a 1-4 unit transaction. For Sellers and Buyers, I can help you keep your dream alive or move on to the next deal. I’ll be by your side working through all of it!!

Aspects of the Code

  • In the Tax Code Section 1031, Real Property can be Sold without paying Capital Gains Tax. The Tax is “Deferred”. This is called a “Like-Kind Exchange”.
  • The number of times a 1031 Exchange can be utilized, is limitless.
  • It is possible for a Taxpayer to Never Pay Tax on the Gain Deferred, by either: holding or exchanging, until the taxpayers’ death. The “Basis” will be “Stepped Up”, meaning, the Estate will pay tax on the increase in value since the date of death to the date of sale.
  • A Taxable transaction occurs when the Taxpayer sells the property. All the Deferred Gain from current property and previously Exchanged properties is Recognized as Taxable.
  • Another way to avoid paying on Taxable Gain up to $500K, is to use the property as an Investment. The Capital is used to purchase a home in an Exchange (1031), rent it for 2 years, then live in it for 2 years and own it for at least 5 years. $250,000 is non-taxable for an individual and $500,000 is non-taxable for married couples filing joint returns.
  • 1031 does not apply to Primary Residence unless it was in an Exchange and rented for at least 2 years immediately after purchase. Also, property Held for Sale (Flipping) is not allowed.
  • 1031 does not apply to property owned by a business, such as: cars, trucks, inventory, machinery, equipment, stocks, cash, bonds, etc., when they are included in the sale of an Exchange.
  • An Interest in a Partnership that owns Real Property generally cannot apply 1031. However, the Partnership as a whole can “Like-Kind Exchange”. This “Exchange” is technical and complex.
  • 1031 Does Apply to Real Property (Real Estate) used for: Investment, a Trade, Business or Production of Income.
  • If multiple properties are bought (Upleg), their value can be no more than 200% of the sold property (Downleg), for the Exchange to be Valid.
  • In short: Real Property (Real Estate) is Sold, another is Purchased and Tax is deferred, or Tax is never owed.
  • A good strategy is to Upleg in the Exchange with more value and a higher mortgage.
  • The Taxpayer never actually receives money from the sale (Downleg Property). An Intermediary or Accommodator is used to take receipt of proceeds and disburse funds to the purchase (Upleg Property).
  • The Accommodator plays an active role in the execution of the Exchange, such as: holding of proceeds, ensures the transaction remains an Exchange and not a Reinvestment, also transfers Title.
  • The Accommodator should be a party to Escrow Instructions and the Acquisition Agreement.
  • “Basis” is the Price of the Property. “Adjusted Basis” is the Price + Improvements + Associated Fees in purchase. When the Adjusted Basis increases the Capital Gain decreases, resulting in less Taxable Capital Gain at the time of Sale.
  • The California Revenue and Taxation Code basically follows the Federal Law.

GET WITH A CPA OR TAX LAWYER TO OUTLINE YOUR PRO’S AND CON’S OF A 1031. FOR BEST RESULTS - BE HONEST AND EXPLAIN YOUR GOALS AND INCOME! I, FOR ONE, WILL BE LISTENING, TO YOU!

The workings of the Code: Follow or FAIL.

  • You have 180 days (about 6 months) to close the purchase of an Upleg Property.
  • Be aware of the month you Sell the Downleg Property. If you sell in December, you have until April 15 to close the purchase of the Upleg Property. That’s about 3.5 months to close the purchase or a Tax Extension must be filed..
  • You have 45 days to identify Upleg Property in writing to the Intermediary/Accommodator and or the Upleg Property Seller.
  • All Properties in the Upleg and Downleg must be in the U.S.
  • The Property purchased (Upleg) must be of at least equal value to the Property sold (Downleg).
  • Equity in the Upleg Property must be at least equal to equity in the Downleg Property. Meaning, it's best to have less equity (higher mortgage) in the Upleg.
  • An Accommodator a.k.a. Qualified Intermediary is required.
  • Do not use an Accommodator who has been your Broker, Attorney or CPA in the past, this may disqualify the Exchange.
  • Choose Accommodator that is a corporation, not an individual, one that is adequately solvent, with no signs of Bankruptcy. Think of what prevents the Accommodator from taking your money and leaving the country? Choose one with reasonable fees and a comprehensive Exchange Agreement.
  • An Exchange between “Related Parties” will be more scrutinized by the IRS for Tax Avoidance. It can be done, but a sale of the Upleg, in less than 2 years from purchase, may raise red flags.
  • If family members occupy or reside in the Upleg Property, they must pay full market rent.
  • The Seller and Buyer must be notified of the Exchange and some signatures are required by them.

I will help you sell your Property or find a new Property. Whether the transaction is an Exchange or Personal Property, the Purchase Agreement is the same and can only be used by California Real Estate Agents that are members of the California Association of Realtors. It is a complex agreement. I will guide you through all of it. I’ll review the associated disclosures with you.

Below are sources for the 1031 Exchange. These links are neither an endorsement nor a referral. I do not receive any kind of fee or commission for providing these links. These links can provide more information related to the Exchange. You are not required to use any of these services when doing business with me and you should always get more than one quote.

Investment & 1031 Accountants

https://www.krostcpas.com/services/1031-exchange-consulting-compliance

https://www.fitz-cpa.com/real_estate.aspx

1031 Accommodators

https://www.ipx1031.com/locations/name/greg-burns/

https://www.firstam.com/title/commercial/1031-exchange-services/