Category: IRS

Considering an Investment Property Sale and Wondering if a 1031 Exchange is Worth It?

That Capital Gains Tax May be a Lot Bigger Than You Think.

In my eBook, The Top 11 Misconceptions About 1031 Exchanges,“ the #5 misstep reads: “The capital gain tax rate is only 15%. I’ll just bite the bullet and pay the taxes now.” To which I respond in similar fashion to famed sportscaster Lee Corso of College Gameday . . . “Not so fast my friend!” If you own real estate investment real estate and are considering a sale and you are debating whether you should just take the capital gains tax hit on your appreciated value or defer those taxes with a 1031 exchange, this post may help make your decision easier.

To start off, I believe it’s generally smart to view a 1031 exchange as an investment structure first, and as a tax-deferral strategy second. Why? Because the owner who intends to sell an investment property has unique reasons for selling. It could be that he or she wants the cash proceeds to use for another purpose. Or may just not want to own investment real estate any longer. In either case, deferring taxes is not a motivation, so a 1031 exchange usually isn’t a consideration.

On the other hand, if you are an investment property owner thinking of a sale and wondering if the tax deferral benefit of a 1031 exchange is advantageous enough to outweigh your desire to simply receive the cash (even knowing that amount will be reduced by capital gains tax), you have some other tax issues to consider. First, know that capital gain tax rates change with some frequency and depending on your income and marital status, your capital gains tax rate currently might be 0%, 15%, or 20% but can go as high as 37%.

But that is not all . . .

The sale of an investment property generally is subject to depreciation recapture tax. This tax is based on your income tax rate and may be as high as your ORDINARY INCOME tax rate, which applies to the portion of the gain attributable to the depreciation deductions you have already taken. In many cases, investment property owners can also defer the state tax on the sale of real estate, so your blended capital gains rate could be as high as 40%. On the sale of a $1 million property, that means walking away with only $600,000 in cash or using a 1031 exchange and reinvesting the full $1 million.

Think about it. You have put in a lot of hard work, courage, persistence, and sweat equity into your property over many years. I don’t know of many investors who would be pleased to send a large percentage of what they earned in appreciation to their “favorite” member of congress to spend, as they see fit.

So, for those investors thinking they might be better off to simply pay the capital gains tax obligation on an investment property sale; it is important to know that the tax hit may be a lot bigger than you think!

But that is not all . . .

There is a confusing part of the tax code called Alternative Minimum Tax (AMT), which actually went away in the 2017 Tax Cut and Jobs Act (TCJA). Don’t get too comfortable in your chair; TCJA kept the AMT but raised the exemption and phase out levels for tax years 2018 – 2025. It will be back in 2026.

There are many other common misconceptions about 1031 exchanges that I encourage you to explore in my eBook which you can download here. You can also contact me at info@1031exchangesite.com.

This is for informational purposes only and does not constitute an offer to buy or sell an investment. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor.  DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

1031 Exchangers – Do Not Mess with Your Deadlines

Misconception #11 – “45 Days and 180 Days Are Not Written in Stone”

Rules matter. Especially as they pertain to certain requirements of a properly executed 1031 exchange. Believe me, I have seen many hearts broken and financial plans damaged by well-intentioned investors who either did not understand the rules of their exchange or did not think that the rules would be so strictly enforced.

There are several common misconceptions around 1031 exchanges that I highlight in my eBook. But the deadlines an exchanger must meet to identify a replacement property and to complete the exchange have absolutely no wiggle room. Zero.

Let us look at those rules more closely.

First, know this: You cannot manipulate, alter, play with, cajole or in some way change the timelines. If you close escrow on March 1st, your 45th day to declare the replacement property is May 16th regardless if that occurs on a Wednesday, Saturday, or Sunday. The last day that you must clarify the replacement property is always 45 days after the closing of the sold or relinquished property. You must close escrow on your replacement property on the 180th day or your exchange is blown. The first thing to do when you close escrow on your relinquished property is to look at your calendar and mark the 45th and 180th day on your calendar.

To be even more specific, the “closing” on the relinquished property occurs when the deed or transfer document is recorded, and the replacement property identification period ends at midnight on the 45th calendar day following the recording date. Similarly, the 180-day exchange period starts on the recording date.

Any Exceptions?

So, now that I have explained there can be no variance in 1031 exchange timeline rules, we need to note there actually can be exceptions, but only two and they are quite rare.

The first extension is provided to armed services members who are actively serving in a combat zone and this exception is defined in Internal Revenue Code (I.R.C.) Section 7508. The second extension is outlined in IRC 165(h)(3)(c) and is extended to exchangers who find themselves subjected to “federally declared disasters” which are generally determined by the President of the United States.

In addition, a natural catastrophe the President determines to be severe enough to warrant the support of federal resources could also provide time extensions in localized areas to 1031 exchange investors. Examples include Hurricanes Harvey and Maria in 2017 and the California wildfires in 2018.

The COVID-19 pandemic created the most recent exception for exchange timelines when the IRS issued Notice 2020-23 on April 9, 2020, extending additional relief for taxpayers impacted financially by the aftereffects of the virus and shutdown of so much of our economy. The Notice extended the 45-day identification period and the 180-day exchange period for exchangers with deadlines due on or after April 1, 2020. Deadlines for both periods were extended to July 15, 2020. No relief was extended to exchangers whose 45-day or 180-day deadlines fell prior to April 1, 2020.

But, as mentioned earlier, even though there have been (rare) exceptions for the timeline rules, investors using a 1031 exchange to sell an investment property and purchase another should assume the 45-day and 180-day deadlines are written in stone. Follow those rules and you can help avoid having your exchange tripped up.

Download my eBook, The Top 11 Misconceptions About 1031 Exchanges today!

You can also contact me at info@1031exchangesite.com.

This is for informational purposes only and does not constitute an offer to buy or sell an investment. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor.  DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

IRS Extends 1031 Exchange Deadlines

This appears to provide that any Affected Taxpayer with a 45-Day Exchange Period or 180-Day Exchange Period deadline between April 1 & July 15, 2020 will have an automatic extension to July 15, 2020.