Regarding Section 1031 of the Tax Code, the tax reform laws enacted in the beginning of 2018 kept the use of 1031 Exchanges for tax deferral when commercial and investment real estate properties are sold but eliminated the use of 1031 Exchanges to obtain tax deferral when personal property is sold. Despite that change, 2018 was a record year for 1031 Exchanges. As we start this New Year, here are some of the trends, issues and key points to remember regarding 1031 Exchanges.
Trends / Market Update
What is in store for commercial real estate in 2019? Many are predicting that the market will continue to transition from a Seller's market towards a Buyer's market, or at least move closer to an equilibrium. Why? Properties are expected to remain on the market longer, meaning that prices may begin to decrease. Couple that with the fact that interest rates have risen, and it is at least plausible the market will begin to balance out.
What we do know is that we have seen investment and commercial real estate transactions remain stronger than owner occupied houses. Because of this, we expect 1031 Exchanges to remain a commonly used and valuable tool for those involved in the real estate market in 2019.
Planning Ahead for a Successful Exchange
Obtaining tax deferral via a 1031 Exchange transaction requires planning, expertise and support. Although we, as a Qualified Intermediary, do provide a lot of information about like kind exchanges, we do not provide legal or tax advice. We also prepare the documentation for the 1031 Exchange, and, most importantly, safeguard the exchange funds. Laying the proper groundwork before entering into an exchange will avoid unnecssary obstacles and lead to a smooth transaction.
Step 1. Instruct your real estate agent or attorney to include a "1031 Exchange Cooperation Clause" in the purchase and sale agreement. We can provide the necessary language.
Step 2. We encourage you to engage your legal and tax advisors to determine if you would benefit by structuring your transaction as a 1031 Exchange.
Step 3. After the contract is signed, contact us and we will answer your questions and prepare the documents that need to be signed prior to closing.
Step 4. Inform us if you plan to 1) use Exchange Funds to make improvements to the new Replacement Property, or 2) acquire the new Replacement Property before you sell your old Relinquished Property.
Step 5. Start searching for Replacement Property! Once you close on your old Relinquished Property the clock starts ticking and you only have 45 days to indentify your new Replacement Property.
Tax Straddling: Pay Taxes in 2019 or 2020?
If your transaction closed at the end of 2018 and you are unable to find new property to indentify or purchase the property that you have indentified, you may still be able to defer paying taxes on your capital gains until 2020. Since you will receive your 1031 funds back in 2019, in certain circumstances, since you did not have control/possession of your funds until 2019, the IRS may allow you to pay taxes on your 2020 tax return instead of 2019. This is in accordance with IRC Section 453(d) and requires your accountant to file specific tax forms. Ask your accountant if you are eligible to take advantage of this "mini" tax deferral.
Commonly Asked 1031 Questions
As the New Year begins, it is a good time to review some commonly asked 1031 Exchange questions.
1. What property type can be purchased to complete a 1031 Exchange?
2. How much time do I have to purchase new Replacement Property after I sell my old property?
3. What should be the sales price of the new property in order to defer my capital gain taxes?