WHAT IS A 1031 EXCHANGE?
Normally, when you sell property held for investment or business purposes for a greater value than that which you originally paid for it, any gain you realize from the sale will be subject to capital-gains tax. However, a Section 1031 exchange—also called a tax-deferred exchange— allows you to sell property and acquire replacement property through an exchange method, allowing you to defer having to pay capital-gains taxes resulting from the initial sale. This allows you to reinvest the sale proceeds without having to pay additional taxes and can therefore be a powerful money-saving tool if used correctly. For example, if you own a rental property such as an apartment or home that you wish to sell because you’d like to purchase similar property in a different location, possibly because you are moving or because you’d like to take advantage of a favorable housing market, a 1031 exchange can help you do so while deferring capital-gains tax.
UNDERSTANDING AN EXCHANGE
There are several requirements of a 1031 exchange:
- All relinquished (old) and replacement (new) property must be property used for trade, business or investment, vacant land, or rental property. If the properties meet these requirements, you are able to exchange any real estate for any other type of real estate.
- You cannot have actual or constructive control of any of the proceeds received from the sale of the old property. By law, all money is held by a Qualified Intermediary (also referred to as an Accommodator or Facilitator). You cannot have an associate or employee, your attorney, broker or CPA hold the proceeds, nor can you leave the proceeds in escrow until the second property is purchased.
- You have 45 days from the date of closing on the old property to identify a list of properties, (3/4 see further notes) from which you will purchase the new property.
- From the date of closing, you have 180 days to close on one or more of the properties from your 45-day list.
- The titleholder on the old property must be the same titleholder on the new property.
- You must reinvest all cash proceeds from the sale, and purchase a new property or properties of equal or greater value, in order to avoid taxation on the gains.
Section 1031 of the Internal Revenue Code provides a remarkable opportunity to build wealth by deferring taxes. Within carefully defined limits, this section of the Code permits you to carry forward the gains you have made on one property into another one, deferring capital gains taxes and, thus, allowing the full use of your equity in the acquisition. An exchange can be much more advantageous than the sale of one property and the purchase of another.
A properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes. IRC Section 1031 (a)(1) states:
“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.”
The 1031 Exchange is an excellent tax planning tool when investors wish to defer the payment of any capital gain and depreciation recapture taxes generated from the sale or disposition of real property or personal property by reinvesting in replacement property.
As a property owner or business owner, the 1031 Exchange can be a powerful investment tool. Call me today to discuss how I can guide you through the process of buying and selling while utilizing the 1031 Exchange.
The following is a list of information which would be required to thoroughly review and prepare your intended exchange:
- What is being relinquished?
- When was the property acquired?
- What was the cost?
- How is it vested?
- How was the property used during the time of ownership?
- Is there a sale pending? If so, what is the closing date?
- Who is closing the sale?
- What are the value, equity and mortgage of the property?
- What would you like to acquire?
- What would the purchase price, equity and mortgage be?
- How is the property to be vested?
What are OPPORTUNITY ZONES?
The Tax Cuts and Jobs Act of 2017 (the “Act”) provides for the designation of certain low-income community population census tracts as qualified opportunity zones and creates tax incentives for those that have capital gains they would like to roll over into another investment, on a tax-deferred basis to encourage investment in such qualified opportunity zones. Despite the similarities between 1031 Exchanges and investments into Qualified Opportunity Funds, there are also significant differences in both their tax treatment and rules around where gains may come from.
The Opportunity Zone program was developed to revitalize economically distressed communities using private investments rather than taxpayer dollars. To stimulate private participation in the Opportunity Zone program, taxpayers/buyers who invest in Qualified Opportunity Zones are eligible to benefit from capital gains tax incentives available exclusively through the program. Possibly the largest difference between the tax benefits of a 1031 Exchange and investing in a Qualified Opportunity Zone is the stepped-up basis on the investment if held for more than 10 years. This means that when the investor sells their investment their basis (the amount of the original investment) is increased to the fair market value at the time of the sale. Since taxpayers are taxed on the difference between their basis and the sale price, this effectively means the transaction will be tax free. In a 1031 Exchange, the original basis follows the investor through the exchange and is used when the replacement property is finally sold, at which time the investor pays the tax on the difference between their basis in the original property and the sale amount of the replacement property.
Q. What is an Opportunity Zone?
A. An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.
Q. How were Opportunity Zones created?
A. Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017.
Q. Have Opportunity Zones been around a long time?
A. No, they are new. The first set of Opportunity Zones, covering parts of 18 states, were designated on April 9, 2018. Opportunity Zones have now been designated covering parts of all 50 states, the District of Columbia and five U.S. territories.
Q. What is the purpose of Opportunity Zones?
A. Opportunity Zones are an economic development tool—that is, they are designed to spur economic development and job creation in distressed communities.