Are you selling a piece of investment or business property with a low basis or high appreciation?
There are some very specialized IRC rules that, if followed, will allow you to avoid income tax when you sell one property with the intention of buying another. It is Section 1031.
There are some hoops you have to jump through to make a 1031 exchange work for you. There are time frames that have to be met, a qualified intermediary to be hired and property to be sold and new property purchased within a certain time frame.
I view 1031 as one of those things where you can really kick yourself if you miss out on deferring taxes by not knowing it exists before you need it. 1031 exchanges are so common in some places that 90% of transactions in real estate held for investment or business (but not stock in trade) is sold that way. Here in Central NY? Not so common.
You might use a 1031 exchange to facilitate a move. You own property in CNY – or somewhere in NYS and you are planning a move – to a retirement location or perhaps for business reasons. Managing property in NY would be difficult if you were living in Florida, so you exchange your property in NY for a Florida business property – a rental unit, perhaps or some other kind of business or investment property.
Or, perhaps, you are planning a move to North Carolina for retirement in the future and you want to participate in the property appreciation going on down there. You exchange your NY property for a property in North Carolina – and then when you move you exchange again – for a residential property or raw land with a buildup.
What are the hoops you have to jump through with the IRS to effect a 1031 property transfer and avoid current income taxes?
Follow strict time frames:
Follow three general rules to avoid taxes:
Exchange qualified property:
Hire a qualified intermediary – property has to pass through this person to take advantage of 1031. Cost? Ranges from $750 to $1500 generally.
Why would someone go through all this? Well, on a property with 100,000 of appreciation you could defer about $20,000 of taxes.
Say you want to get rid of some raw land worth $500,000 that you inherited through a trust many years ago and buy some rental income property - and you would like to avoid the tax on the $450,000 of gains.
By deferring the tax on the $450,000 – about $80,0000 – you have more to invest in your next property. Or maybe you have a fully depreciated apartment building here and you want to purchase rental property in Florida . Same question – how much of a benefit is it to you to eliminate income taxes from the transaction?
Or maybe you are a professional person who wants to buya building to house their practice. You own an apartment building or a strip mall or some other business property – you can exchange it for a property to house your practice – or even raw land plus a build up – as long as it is completed in the time fram required by law in a 1031 exchange.
The first thing you do is talk to your tax, legal or fee-based financial advisor.
Then you hire a qualified intermediary. You cannot sell the property and receive the proceeds and then reinvest. The minute the money is in your control – you owe the tax.
The cost ranges from $750 to $4000 or so depending on the complexity of the transfer.
Important to note who can act as a QI for you? Not your attorney. Unless that is the only representation they have made for you.
What income or estate planning techniques are fostered by a 1031 property exchange?
Some of this week’s topic may sound a little cutting edge – but this process has been around since 1921.
In order for this to make sense, there needs to be enough property value and taxes saved to make it worth paying the qualified intermediary.
Doing a 1031 exchange does not cost the seller of the property you want to buy anything. It does not delay the closing – other than you have to meet the 45 day identification period requirement.
You could avoid – and perhaps eliminate a lot of income taxes.
There is a tax loophole with property exchanges that if it fits your situation could turn appreciation on a business property into a largely tax-free future sale.
We’ve been talking about section 1031 property exchanges this week. Based on a discussion with a local QI it appears you can
I’m sure the IRS will find a way to close this loophole eventually, but for now, if the situation fits – take it!
How this could play out is:
If this sounds like a good idea to you, it is important that you start off getting good advice. There are specialists who can help with this – make sure you find one.