What is a 1031?
“In general—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.”
-Involves selling investment real estate THAT HAS BEEN HELD FOR INVESTMENT and replacing it with other qualified real estate that will be held for investment. Take note that NO time frame is given by the IRS how long the property needs to be held.
What qualifies?
-Commercial properties
-Farmland
-Developed lots for investor – held for appreciation
-Warehouses
-Apartment buildings
-Rental houses
-Vacation homes, under certain circumstances
-Bare land
-Some personal property, baseball cards, airplanes
What doesn’t qualify?
-A principal residence
-Spec house
-Developed lots – inventory for bld
-Flipped properties
Why do a 1031?
-AVOID TAXATION – short term gains as high as 35% federal and around 7% state. Long term gains 15% but still must pay state taxes around 7%
– Increase net worth
-Increase cash flow – vacant land for cash flowing property
-Consolidate holdings (10 houses for 1 building)
-Diversify risk. Sell property and buy 10 houses in different locations.
Process of 1031
Identification –
-New property must be identified in writing within 45 days of sale of relinquished property
-Can identify up to three properties of any value
-Can identify more than three properties but total value of all three properties can not exceed 200% of relinquished property value
-Can identify any number of properties BUT you must buy 95% of FMV of all properties identified
Closing on new properties
– 180 days from sale of relinquished property TOTAL, not in addition to 45 days
This is NO extension provision. You must identify and close in the appointed time frames or you will pay the tax. If you back out on day 46 or day 181 you will blow the exchange.
Reverse 1031
-Buy new property BEFORE selling relinquished property
-45 and 180 day limits apply
-Need money to buy new property
-Could refinance relinquishing property to get cash to make new purchase
-Could find cash or financing elsewhere
-Need to use special purpose entity to “park” the relinquished property before selling
Selecting Intermediary to do the Exchange
-Tax professionals
-Value added services – not just hold your money
-Are they sufficiently bonded?
-E&O Coverage
How Intermediaries get paid
Flat fee
Interest on deposited funds
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