My father-in law and I were watching Million Dollar Listing the other day, and the brokers had a seller and a buyer that were trying to get their respective deals to close quickly due to "tax issues." Whenever accounting issues come up in daily conversation, tax nerds, like ourselves, get excited....so I thought this would make a good topic for the blog this week.
What is a 1031 "Like-Kind Exchange"
Generally speaking, a like-kind exchange is a swap of one business or investment asset for another, and you will have either limited or no tax due at the time of the exchange. Basically, the IRS allows you to change the form of your investment without cashing out or recognizing a capital gain, allowing for your investment to grow tax deferred. There's currently no limit on how many times you or how frequently you roll over the gain from one piece of investment real estate to another.
There is one catch! You can trigger a gain known as depreciation recapture when depreciable property is exchanged in a 1031. This type of gain is taxed as ordinary income...not good! If you swap one building for another, you can avoid this recapture, but if you exchange improved land with a building for unimproved land without a building, the depreciation you previously claimed on the building is "recaptured" as ordinary income...hence the term, "like-kind exchange." in order for the swap to qualify as a section 1031 exchange.
What you need to know when contemplating a 1031 "Like-Kind Exchange"
- Provision is only for investment and business property;
- "Like-kind" is a VERY broad term, but you should consult an tax-professional before pulling the trigger on an exchange;
- You can do a "delayed exchange," also known as a Starker exchange;
- Two Key Timing Rules:
- You must designate, in writing, a replacement property within 45 days of the sale of your property; and,
- You must close on the new property within 180 days of the sale of the old.
- The IRS allows you to designate three replacement properties as long as you eventually close on one of them; and,
- If you receive cash...it's taxed.
Section 1031 exchanges can be great for investors, but you have to be wary of the potential tax pitfalls. If you have any questions, feel free to reach out to our tax advisors.