For every real estate investor or owner looking to do a 1031 Exchange, it’s imperative to comply with Section 1031 of the IRS Code. Here’s a refresher of information on what 1031 or like-kind exchanges are, how they work, and how they’re reported. With the passing of the 2018 tax bill there have been no updates to this IRS Code.
Investment property owners are able to defer capital gains taxes using 1031 tax-deferred exchanges, which have been in the tax code since 1921. No new restrictions on 1031 exchanges of real property were made in the 2018 tax law. However, the tax 2018 law repealed 1031 exchanges for all other types of property that are not real property.
This means 1031 exchanges of personal property such as: business assets, aircraft, artwork, coin collections, construction equipment, and fleets of autos or trucks are no longer be permitted.
What is a 1031 Exchange?
A 1031 Exchange is a transaction in which a taxpayer is allowed to exchange one investment property for another (like-kind), and deferring the tax consequence of a sale. To be considered “like-kind” the property must be in the same nature and character, even if they differ in grade or quality. The transaction is authorized by Section 1031 of the IRS Code. IRC Section 1031 allows an investor to postpone paying tax on the gain if they reinvest the proceeds in similar property, as part of a qualifying like-kind exchange.
Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free. Savings in a 1031 exchange are considered “deferred” because you’ll eventually pay a capital gains tax, depreciation recapture, and state taxes if you sell the new property. However, investors can avoid these taxes indefinitely if they don’t sell, or if the like-kind exchange is used again.
Timelines for a 1031 Exchange
While a like-kind exchange does not have to be a simultaneous swap of properties, the investor must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidential declared disasters. The investor must follow the strict 45/ 180-day guidelines for an exchange.
Once the investor sells their property they have 45 days to identify property of equal or greater value. The identification must be in writing, signed, and delivered to a person involved in the exchange, like the seller of the replacement property or the qualified intermediary.
Once identified, the investor then has 180 days from the day they sold their property, to acquire the property identified (or 135 days from the end of the 45-day period). In short, the new property has to be identified within 45 days of the initial sale and purchased within 180 days of the sale.
Finding a Commercial Property Within 45 Days
It’s common for investors to reach obstacles when complying with 1031 Exchange regulations. Most common is finding a replacement property in the first 45 days after the property sale. The IRS generally doesn’t allow for time extensions, which is why time is of the essence. One way to overcome this obstacle is hiring or contacting a commercial real estate broker to help find a replacement property. Brokers have the network and connections to find suitable listings in a faster turnaround time.
Here are more pros and cons of a 1031 Exchange.
How is a 1031 Exchange Reported?
The exchange must be reported to the IRS using Form 8824 “Like-Kind Exchanges” and filed with the tax return for the year in which the exchange occurred.
The form requires the following information: descriptions of the properties exchanged, dates that properties were identified and transferred, any relationship between the parties to the exchange, value of the like-kind and other property received, gain or loss on sale of other (non-like-kind) property given up, cash received or paid; liabilities relieved or assumed, adjusted basis of like-kind property given up; and realized gain.
If the investor does not specifically follow the rules for like-kind exchanges, they may be held liable for taxes, penalties, and interest on the transactions.