Real Estate Advice - 1031 Exchange

[93B18]

Need some advice from the RE gurus here. I have a rental property that I am thinking about selling and placing that equity in another property. I have purchased that other property already and I don't plan on selling the first rental property till later this year. Now when I do sell it though can I do a 1031 exchange and transfer the equity into the new property that I bought say 9 months ago? Both of these places are rentals. TIA for the replies.

 

[Dtrigg]

I've look at several 1031 situations, but they just didn't work out for me. Eventually you have to do the capital gains number.

As I understand, a 1031 has to be for likewise real estate, e.g. a $100,000 property for a $100,000 property. So, if I understand your question, I don't think you will be able to build up your equity in the other property. Best to discuss with an expert.

Good luck.

 

[steveny]

Because you have already closed on the second property you will not be able to do a 1031. You have to pick out the property you will invest the gains into before you buy it. Also a third party must handle all the money. You can not have access to the funds at any time during the transfer.

Example:
Buy a property. Put it up for sale. Before the property sells have another picked out to buy and contingent upon you selling the first property. Have an attorney handle the transfer of the funds.

I usually buy a rundown house and fix it up and rent it out. Then borrow against it enough to pay off the first mortgage and also buy another property cash out. Then buy another property and fix that one up. Borrow again to buy two more. Buy the next two and borrow against both of them allowing me to buy four more. But this is where I take some of the profit in cash equity. Remember there is no tax on borrowed money. :biggrin:

 

[93B18]

So there are no other tax-deferred exchanges I can use to transfer the equity from one property to another exisiting property? Bummer. I knew the 1031 exchanges had some time period to find another property to transfer to.

 

[WeakestLink]

Disclaimer: This is just my opinion. Do not assume any of this info to be true. Refer to your accountant/attorney for advice. Etc, etc.

You may still be able to do a 1031. It's called a reverse 1031 exchange and the IRS has indicated that it is ok to do although they have not had to rule on it as of yet.

Essentially, you can buy a property as part of the 1031 and sell the property to be exchanged after the fact. The reasons why this isn't always popular is 1) you have to have the cash to put down on the new property (even though you haven't gotten the proceeds from the sale) and 2) you have to know the amount to put down so that it equals your proceeds from the sale (otherwise, you may be taxed on part of the proceeds which isn't a big deal)

Here is an article that outlines reverse Starker exchanges.
http://realtytimes.com/rtcpages/20030929_starker.htm

Even if you cannot make it work out, the good news is that LT cap gains is only 15% (I think) although your recaptured depreciation could be ugly depending on how long you've had the property.

Good luck.

 

[Cruzrmm]

I've look at several 1031 situations, but they just didn't work out for me. Eventually you have to do the capital gains number.

As I understand, a 1031 has to be for likewise real estate, e.g. a $100,000 property for a $100,000 property. So, if I understand your question, I don't think you will be able to build up your equity in the other property. Best to discuss with an expert.

Good luck.

My reply should not be considered as legal advice or tax reporting guidelines. This is only meant to add insight to a confusing tax alternative. If the 1031 Tax Exchange guidelines are followed exactly then deferring a capital gain tax could allow for additional initial venture capital for increased equity in your next purchase. Many savvy Buyers can defer the tax and continue to roll-over the investment capital to see a tidy profit in short time.

It is true that you will have to report the gain but the tax can be deferred immediately and almost indefinitely, thus allowing you to utilize your capital for further investment and potential profit. As stated in the previous post, the re-investment of the gain is what will defer the taxes on that gain. The 1031 Tax Exchange guidelines have been relaxed somewhat over the last few years but they are still quite complicated and very specific as to performance. It would be prudent to hire a 1031 Tax specialist if you are not 100% sure of the process. Heck, I have owned my own RE office for 8 years and I have taken many seminars on the 1031 Tax Exchange and I would still hire a specialist. General RE Brokers and RE attorneys may know about the process and advantages but they are not specialists. In the long run a 1031 Tax specialist (attorney tax specialist or RE Broker tax specialist) can save you $1,000s !!! Kind of like needing a medical specialist and going to a general practitioner. Special care requires a special care giver.

It is a rule of thumb to always invest in a property of the same value or higher value. In this manner you will shelter all of your gain from the previous liquidation. If you choose to invest in a “like” property of less value then the difference of that value and the gain is what will be taxed. Remember that all sales costs and fees are tax deductible (i.e. marketing, agent fees, Closing costs, mortgage fees, etc.). It is also necessary to follow ALL of the gov’t guidelines EXACTLY! It is a requirement that a 3rd party hold the liquid assets after Closing. After Closing you cannot “touch” the funds- meaning that you can have absolutely no access to the money in any way, even if you never use it. At Closing the Settlement check has to go to the 3rd party. Closing funds can not be issued to you and then you transfer the check to your tax agent. One missed step will void the process. The procedure is extremely time sensitive in regards to stipulating a replacement property and then closing on that property. It is even possible to “replace” your property with more than one property to meet the total investment amount needed to shelter the gain. It is also possible to build new construction to shelter your gain, but be aware that if your contractor does not meet the completion date that you will be in violation of the guidelines and subject to tax.

”Like” properties for exchange are sometimes easily identified (residential house – residential house / subdivision) but can also get somewhat convoluted (residential house on acreage with a small at home business – house with no business / subdivision). Both properties are primary residences but one has already claimed small business income for a percentage of the dwelling on past tax returns. Commercial business and undeveloped parcels are also open to interpretation. This is where the experts make their money!

These examples are only a small representation of the different possibilities of exchanges. Believe me, it is possible to get very creative with these exchanges to the point of involving multiple properties, buyers, and sellers. Depending on the scope of your investments, your age, yearly tax liability (short gain / long gain, etc.), other variables, and the amount of gain/tax it is in your best interest to talk to a Tax expert and let them counsel you as to what is best for your individual situation. If it is even a remote possibility that a 1031 Tax Exchange would benefit you and is something for you to consider then don’t waste time thinking about it. With all of the time considerations, restrictions, and other mandatory requirements it is necessary to begin the 1031 Tax Exchange process long before Closing on a property that is currently on the market for sale. Many people when listing a property for sale with a licensed RE Broker will notate the listing that a 1031 Tax Exchange is a possibility so that both Buyers and Sellers know that you are working with time and performance considerations.

Even if you go through all of the steps and the exchange is approved, if you do choose to change your mind the process is not binding (unless you have signed a Buy/Sell contract or other enforceable contract that does not stipulate or allow an escape clause). Be VERY careful with contracts and what you sign! Hire a professional- preferably someone that has multiple referrals and recent experience with the 1031 Tax Exchange. Go into the transaction with your eyes wide open, a calendar close at hand, and keep an attitude that it will benefit you to work with the cash in your hands rather than paying it immediately to the gov’t. You can almost consider it an interest free loan!

Hope this condensed description helped those that were unfamiliar with deferring RE tax gains and those that were uncertain if this program would benefit them.