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Defer Capital Gains on Investment Properties With a 1031 Like-Kind Exchange

Defer Capital Gains on Investment Properties With a 1031 Like-Kind Exchange

Did You Know You Can Defer Capital Gains on Investment Properties With a 1031 Like-Kind Exchange?

As an investor in real estate, you may be able to take advantage of IRS Section 1031.

A 1031 exchange is also referred to as a like-kind exchange because it is a swap of one investment property for another for tax purposes.

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Here Are the Top 5 Things You Should Know About Section 1031

  1. You can change your investment to another property without cashing out the fund or recognizing the income as capital gains. This allows for tax-deferred growth of your initial investment.
  2. There is no limit to how often you use the Section 1031 option. You can roll over your initial investment as many times as you like. You will only need to pay capital gains on the investment when you cash out.
  3. Like-kind is a general term that allows you to exchange many types of investment properties – they do not need to be the same type of investment. For example, you can exchange an apartment building for raw land or a strip mall for another type of business.
  4. One rule you need to be wary of is the Depreciable Property rule. If you swap improved land with a building for unimproved land without a building, the depreciation you previously claimed on the building will be recaptured as ordinary income.
  5. There is a 45-day rule that states you must designate the replacement property for the property you sold. And a 180-day law states you must close on the new property within 180 days of the sale of the old property.

This sounds pretty simple, but some exceptions and clarifications may come into play with your individual scenario.

What are the Downsides?

Eventually, the tax deferral will end and there could be a big tax hit when that happens. Estate planning can help, as tax liabilities end with death. Your heirs can inherit the property at the stepped-up market rate value and they won’t be required to pay the taxes you postponed paying with the Section 1031 scenarios.

What Reporting is Necessary?

You are required to submit Form 8824 when you file your tax return for the year in which the exchange occurred. The form requires that you provide details of the properties including each property's value.

Can Residential Properties Be Included?

Your primary and secondary residences do not qualify for Section 1031 unless you rent it out for a reasonable period and did not live there during that time. At that point, the property becomes an investment property and may qualify.

What Tax Legislation Affects Section 1031?

President Trump passed the Tax Cuts and Jobs Act (TCJA) in 2017 which altered 1031 exchanges. TCJA excluded some personal and intangible property from the deferral calculation. President Biden has proposed more limitations on Section 1031, but as of January 2022, there have been no legislative changes.

This is another reason you should speak with a qualified CPA, as they are in tune with current and pending legislation and can advise you on tax planning to help minimize your tax liabilities.

How SVA Can Help

SVA is known for its deep real estate industry expertise. Give us a call and let’s talk more about how we can help you.

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Biz Tip Topic Expert: Chris Fearn, CPA

Chris Fearn, CPA

Chris is a Principal with SVA Certified Public Accountants with expertise in the real estate and nonprofit industries. In his role, he manages and performs audits for owners of affordable multifamily housing projects receiving Section 42 Low-Income Housing Tax Credits.

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