A lot of talk on #RETwit about 1031 exchanges, and for good reason.
Exchanges are a fantastic tool to grow wealth over a lifetime and even a great estate planning tool in passing tax free, stepped up wealth to your heirs.
Explanation of theory, execution and more. THREAD👇🏼👇🏼
Exchanges are a fantastic tool to grow wealth over a lifetime and even a great estate planning tool in passing tax free, stepped up wealth to your heirs.
Explanation of theory, execution and more. THREAD👇🏼👇🏼
https://twitter.com/tannerkey6/status/1324143326145224705
WHAT -
A 1031 exchange refers to Sec 1031 of the Internal Revenue Code relating to “Nonrecognition Of Gain Or Loss From Exchanges Solely In Kind”.
The principle behind the exchange is deferral of basis and tax, so you can compound wealth tax free.
A 1031 exchange refers to Sec 1031 of the Internal Revenue Code relating to “Nonrecognition Of Gain Or Loss From Exchanges Solely In Kind”.
The principle behind the exchange is deferral of basis and tax, so you can compound wealth tax free.
A property can be sold, and tax can be deferred by exchanging the property for another similar property or properties that better fits your needs.
The deal sounds like a no brainer - Sell, take a gain and don’t pay tax. The catch is you have to meet certain rules.
The deal sounds like a no brainer - Sell, take a gain and don’t pay tax. The catch is you have to meet certain rules.
HOW -
To answer @TannerKey6 original question - the mechanics of the process. Note I live in Texas where 90% of the 1031s I see occur.
An escrow office or title attorney generally sits in the middle of the 1031, serving as a Qualified Intermediary.
To answer @TannerKey6 original question - the mechanics of the process. Note I live in Texas where 90% of the 1031s I see occur.
An escrow office or title attorney generally sits in the middle of the 1031, serving as a Qualified Intermediary.
The QI actually holds the cash from the proceeds of sale while the replacement property is targeted and acquired.
Day 1 - The original sale closes. Cash goes into escrow with QI.
Day 45 - A replacement property must be identified.
Day 180 - the exchange must be completed.
Day 1 - The original sale closes. Cash goes into escrow with QI.
Day 45 - A replacement property must be identified.
Day 180 - the exchange must be completed.
WHY -
The main reason why is obvious. To defer tax and continue to compound tax free. It’s one of the best parts of real estate and should be considered any time a sale of investment property occurs.
You could always defer into an IRA, but I don’t recommend that - see below:
The main reason why is obvious. To defer tax and continue to compound tax free. It’s one of the best parts of real estate and should be considered any time a sale of investment property occurs.
You could always defer into an IRA, but I don’t recommend that - see below:
https://twitter.com/baldridgecpa/status/1321850052009222144
Major distinctions between a 1031 owned in a taxable account and a 401k or OIRA -
1. You still enjoy the tax benefits and cash flow while deferring tax in a 1031.
2. You can still achieve a step up in basis at death. This is HUGE. With a 401k, at some point you or your kids pay.
1. You still enjoy the tax benefits and cash flow while deferring tax in a 1031.
2. You can still achieve a step up in basis at death. This is HUGE. With a 401k, at some point you or your kids pay.
MORE THOUGHTS -
A. There is no limit as to how often or how many times one can use an exchange.
While it specifically doesn’t apply to assets held for sale (spec developer), it is a great tool for the value add developer to improve, stabilize and sell over multi-year timeline.
A. There is no limit as to how often or how many times one can use an exchange.
While it specifically doesn’t apply to assets held for sale (spec developer), it is a great tool for the value add developer to improve, stabilize and sell over multi-year timeline.
B. One property may be exchanged for several smaller properties, or several small for one large.
The more moving pieces complicate the process and risk the 180 day rule.
B2. Leverage and capital may also be added along the way and used with Cost Seg to create losses.
The more moving pieces complicate the process and risk the 180 day rule.
B2. Leverage and capital may also be added along the way and used with Cost Seg to create losses.
C. A Qualified Intermediary must assist along the way. They will assist you through the deal and consult you through the process and the specific mechanics of your situation. They will be worth the money spent.
D. There is a “reverse 1031” where you first buy and then sell.
D. There is a “reverse 1031” where you first buy and then sell.
E. You can 1031 a vacation home by first converting it into to a rental property.
F. Worth noting the term “like kind” is fairly liberal. You can exchange many types of real property for many others. Of course seek specific guidance for your situation.
F. Worth noting the term “like kind” is fairly liberal. You can exchange many types of real property for many others. Of course seek specific guidance for your situation.
PITFALLS -
I. The biggest pitfall of 1031 deals is that it can be tough to execute a great purchase and a great sale within the 180 day period.
As always - Don’t let the tax tail wag the dog. It is generally better to pay cap gains tax than to do a crappy deal on either side.
I. The biggest pitfall of 1031 deals is that it can be tough to execute a great purchase and a great sale within the 180 day period.
As always - Don’t let the tax tail wag the dog. It is generally better to pay cap gains tax than to do a crappy deal on either side.
II. Another potential pitfall is the ‘boot’ component of 1031.
All sale proceeds must go into another deal. Tax will be paid on the first dollar to come out of the deal, all the way down to the property tax basis.
Basically, you cannot pull money out of the deal - Buy bigger.
All sale proceeds must go into another deal. Tax will be paid on the first dollar to come out of the deal, all the way down to the property tax basis.
Basically, you cannot pull money out of the deal - Buy bigger.
III. Watch out when a building or developed property where depreciation has been taken is exchanged for a piece of raw land. This can trigger recapture depreciation.
IV. As always there is no free lunch. This is a deferral of tax with the basis continually getting beaten down.
When it is time to pay the piper, if cost segs are taken over time there will be very little basis and lots of recapture.
Be ready to pay tax upon the sale.*
When it is time to pay the piper, if cost segs are taken over time there will be very little basis and lots of recapture.
Be ready to pay tax upon the sale.*
*One final note - 1031 property is eligible to receive a step up in basis on death. If there has been or is about to be a 1031 into a legacy asset planned to be kept for many years or a lifetime, it might be a good time to put the asset into a Family Ltd Partnership or trust..
IN CONCLUSION
I have sort of just begun to scratch the surface on 1031 exchanges, their uses and how they work mechanically - take one of your title lawyer or escrow officer buddies out to lunch.
It is always something to look at when selling an asset with a gain.
I have sort of just begun to scratch the surface on 1031 exchanges, their uses and how they work mechanically - take one of your title lawyer or escrow officer buddies out to lunch.
It is always something to look at when selling an asset with a gain.
Opportunity zones can accomplish a similar goal with some distinct differences. If your target replacement property is in an OZ they should definitely be considered as well.
That is something I will break down in a future post.
That is something I will break down in a future post.
The post pinned to my profile below is a good read alongside of this, which links back to a couple of @sweatystartup threads as well. The 1031 is a small part of the whole benefit that real estate can bring to your business and tax life.
https://twitter.com/baldridgecpa/status/1318650269291393024
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