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Category Archives: 1031 Exchange Replacement Property

Six Myths About 1031 Exchanges – Part 2

So you want to do a 1031 exchange, but you’re not sure where to start. You’ve heard a lot of crazy things about this great tax-deferral strategy, so you’re just not sure. In a recent post, we’ve taken the guesswork out of 1031 exchanges by debunking some of the most common myths. Read on for a few more. A taxpayer cannot complete a 1031 exchange with a related party. FALSE! Related parties can buy or sell property in a valid 1031 exchange. When related parties (e.g., parents, spouses, children, siblings, etc.) exchange property, the related party is obligated to own the property for at least two years following the exchange […]

Six Myths About 1031 Exchanges – Part 1

Today it seems like everyone is doing a 1031 exchange. And why not? Deferring capital gains taxes on the sale of investment or business property can be very lucrative for an investor. They can take that money and reinvest it in bigger and better properties, and build their portfolio faster. Unfortunately, with this popularity comes a lot of misinformation. Read on for a few of the most common 1031 myths. All tax liability is deferred in a 1031 exchange. FALSE! Boot is an important concept to understand in 1031 exchanges. Boot is any cash not spent on the purchase of replacement property. Boot is fully taxable regardless of the investor’s […]

Recaptured Depreciation Matters In A 1031 Exchange

Section 1031 of the IRS Code permits investors to defer payment of tax on the gain from the sale of property held for productive use in business, trade or investment. This is true so long as the property is exchanged for a “like kind” asset (or assets). It’s a great tax-deferral strategy, but there is a significant tax liability that many investors don’t initially consider – recaptured depreciation. In any 1031 exchange, an investor must recapture all depreciation at 25%. Depending on how long you’ve owned your investment property, the depreciation recapture could be a bigger tax liability than the capital gains tax. As a professional who has provided qualified […]

Not Every 1031 Exchange Goes As Planned

A recent case came out of U.S. Tax Court that illustrates the dangers of structuring complex 1031 exchanges to avoid significant capital gains taxes. It also illustrates the reality that even the top tier accounting and law firms can make a misstep when it comes to advising on the more nuanced transactions. In the end, the plaintiffs, a power company, was forced to pay taxes and penalties related to $539 million in tax benefits it claimed from a disputed 1031 exchange transaction. The case is Exelon v. IRS and makes for an interesting read for anyone involved in 1031 exchanges.

What are the disadvantages of a 1031 exchange?

While a 1031 exchange can be a great tool to defer capital gains, it doesn’t come without at least one disadvantage. When you engage in a 1031 exchange, there is a reduced basis for depreciation on the replacement property. The tax basis of the replacement property is essentially the purchase price minus the deferred gain on the sale of the relinquished property. Thus, the replacement property includes a deferred gain that will be taxed in the future if/when the investor sells the property without conducting another exchange. By no means is the “disadvantage” a reason to say no to a 1031 exchange. But by understanding it, you can better prepare […]

“Equal Or More” Investments Are The Rule In 1031 Exchanges

So you want to do a 1031 exchange and defer capital gains taxes. Great. All you have to do is sell your old property and buy something new, right? Sort of. There are myriad rules surrounding legitimate 1031 exchanges, and the value of your replacement property is one of them. In order to defer 100% of your capital gains, the value of your replacement property must be equal to or greater than the property you sold. In determining the equal or up number, you must keep two important factors in mind. The first thing has to do with debt. The amount of money used to pay off debt (any mortgages, […]

Beware Hidden “Boot” Risks In A 1031 Exchange

One of the golden rules of 1031 exchanges is that if you receive any cash out of the transaction, it is considered “boot” and subject to capital gains taxes. Most investors understand this. But there is one element of “boot” that often catches investors off guard, and it has to do with mortgages and other debt. If you fail to consider outstanding loans during the 1031 transactions, you can find yourself facing unintended taxes on unexpected boot. How so? If you don’t receive cash back but do see your liability go down, the reduction in debt will be treated just like cash. Let’s say you had a mortgage of $1,000,000 […]

How broad is the definition of “like-kind” in a 1031 exchange?

Although the IRS does not set forth a definitive description of what “like-kind” means, they do offer guidance. Both properties involved in a 1031 exchange must be “the same nature or character, even if they differ in grade or quality.” From my own practical experience working with 1031 exchanges for nearly two decades as a qualified intermediary and an investor myself, I have seen many seemingly incongruent “like-kind” exchanges that were permitted by the IRS. Things like: – Exchanging an apartment building for a duplex. – Exchanging a single family rental property for a commercial office building. – Exchanging rental property for a restaurant space. Seeing the diverse nature of […]

What if my replacement property costs less than my relinquished property?

Even investors who understand the basics of 1031 exchanges sometimes get caught out when it comes to finding replacement property that is equal or greater in value to the relinquished property. Perhaps the investor has located the right replacement property and it actually costs less than the investment/business property he or she sold. Must the investor keep looking until they find something else more expensive? Or must they forego a 1031 exchange altogether if they really want to buy that specific parcel of replacement property? The answer to both questions is…no. When faced with a situation where replacement property costs less than relinquished property, it is possible to do a […]

Don’t Overfund Your 1031 Replacement Property Loan

The IRS has strict rules for determining the validity of your 1031 exchange in order to completely defer all capital gains taxes. You must: (1) buy replacement property that is equal or greater in value than your relinquished property, (2) use all the cash proceeds from the sale of your relinquished property toward the purchase of your replacement property, and (3) replace the value of your debt on the relinquished property. If, when you take out debt on your replacement property it exceeds the amount of debt you had on your relinquished property, the difference may be considered “boot” and become taxable to you. To avoid this scenario, be sure […]