Exchanging Thoughts

Many investors sell investment property that includes their personal residence. We see this in many farm operations where the house is located on the farm. Also, many city dwellers recently converted their personal residence into a combination of rental property and their home.

Sellers are sometimes asked to provide financing to the buyer of their property as part of the sale negotiations. Usually structured with payments spread out over a number of years, sellers can report the transaction as an installment sale under Section 453 of the tax code. The installment sale method would allow the seller to defer the gain over the life of the note. Taxes are paid based on the payments received each year and part of each payment is the return of your basis, part is your capital gain which will be taxed according to capital gains tax rates and the interest paid is treated as ordinary income.

Owners of appreciated real estate face tough decisions: (1) hold onto a property that may not be working for them anymore so they don’t have to pay the high tax liabilities associated with selling; (2) sell and pay the capital gains, 25% depreciation recapture and possibly the 3.8% Net Investment Income Tax; or (3) complete a 1031 exchange, defer the gain and reinvest all proceeds into more desirable replacement property. For those investors exchanging, they can buy traditional fee interest in property or an investment vehicle known as a Delaware Statutory Trust (DST). Regardless, all of the 1031 exchange rules and timelines remain the sale. The DST is simply a different replacement property option.

On Friday March 27th, the President signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) into law. This $2 trillion dollar stimulus bill will provide relief to individuals, businesses, and state and local governments, and will bolster an economy gravely shaken by the unprecedented impact of the Coronavirus.

The Internal Revenue Code (IRC) section 1031 requires that the same taxpayer who relinquished property also take ownership of replacement property in a like kind exchange. Partnerships, corporations, LLCs, and all their various structures (hereafter “structure/entity”) are considered an individual “taxpayer” in the eyes of the IRC; not the individual members, shareholders, partners, etc. (collectively “members/partners”).

A tax-deferred exchange allows you to defer federal capital gain taxes when like-kind real property within the exchange timeline. While most states with an income tax regime recognize a 1031 exchange and allow you to defer the state gain as well as the federal gain there is one state that does not. This Tuesday Tip looks at state requirements in a 1031 exchange.

When you think of a tax-deferred exchange, you often think of like-kind exchanges and what qualifies
as like-kind. This More, More Monday we will discuss 30 year leases, an often overlooked property that qualifies as like-kind in a 1031 exchange.

We have discussed many of the benefits of a tax-deferred exchange but what can a 1031 exchange really do for you? This Friday Free for All will provide an example of the true power of a 1031 tax-deferred exchange. Let’s look at a specific scenario and how a 1031 exchange can benefit the seller.

On this Wealth Building Wednesday, we would like to take a moment to remember all the heroes who have fought for our independence, freedom and unity. The brave men and women who have laid down their lives for our country deserve to be remembered not only today, but every single day.

This Friday Free for All we will go back to basics. We will look at 1031 tax-deferred exchanges, what they are, their benefits, how they work and the rules involved.