1031 Exchanges
Will President Trump repeal of 1031 exchanges? Rumors abounded that President Obama would do just that. It never happened. Real estate executives are currently waiting for President Trump’s tax reform program. Some experts think part of the tax reform includes 1031 exchange elimination.
Forbes quoted CBRE Americas head of research Spencer Levy. “Levy said the GOP tax reform plan would allow businesses to fully expense real estate investments apart from land. This would lead to the 1031 exchange elimination because the full expensing would enable a new type of exchange for all transactions apart from land. 1031 exchange elimination in this manner would lower the capital gains tax rate for businesses.”
What are 1031 Exchanges?
Under current law, an exchange of property, like a sale, generally is a taxable transaction. If you sell a business or farm, taxes are due on the gain from your basis (your cost). 1031 exchanges are a special rule that provides that no gain or loss is recognized if you exchange property for a like-kind property. “Like-kind is pretty broad. Currently, you can continue exchanging one property for another and not pay any capital gain taxes.
1031 exchanges do not apply, however, to exchanges of stock in trade or other property held primarily for sale, stocks, bonds, partnership interests, certificates of trust or beneficial interest, other securities, etc. They do not apply to your primary residence.
A like-kind exchange does not require that the exchange of properties happen simultaneously. As long as you identify the property received in the exchange within 45 days and ultimately received within 180 days of the sale of the original property, then gain is deferred.
7 Key Rules About 1031 Exchanges
Robert Wood writing in Forbes about 7 Key Rules About 1031 Exchanges says, “There’s no limit on how many times you can do a 1031 exchange. You can roll over the gain from one piece of investment real estate to another, then another and another. You may have a profit on each swap, but you avoid tax until you actually sell for cash.” But, he cautions, be careful and do it right. Doing it right means to Wood:
- Investment, Not Personal. 1031 is for investment and business property, not personal.
- Like-kind is Broad.
- Delayed Exchanges are OK.
- Designating Replacement Property. There are two timing rules you must observe for a delayed exchange.
- Close Within Six Months.
- Cash Taxed. Cash left over? The intermediary pays it to you at the end of the 180 days. That cash or “boot” gets taxed, generally as a capital gain.
- Beware Mortgages. You must consider mortgage loans or other debt on the property you relinquish, and any debt on the replacement property you acquire. If you don’t receive cash back, but your liability goes down, then you should treat that as income just like cash.
There are some pitfalls to 1031 exchanges:
- Substantial fees in the transfer (agents, lawyers—yes, even accountants) can reduce the expected benefits making the transaction unprofitable.
- Often substantial premiums must be paid to attract sellers of property to engage in 1031 exchanges.
- Current tax rates are at historical lows (particularly capital gains at 15 percent). The rates are likely to increase in the future and could greatly reduce expected benefits.
- 1031 exchanges can and do fail, which can result in costly litigation. After all, a 1031 involves two properties, which doubles the potential deal killers.
1031 Exchanges Repealed?
I suspect as the government looks farther and farther afield for money to run the government, 1031 exchanges will face elimination. Government will find some way to end the rollover ad infinitum. Meanwhile, enjoy your 1031 exchanges.
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