• Mike Gratland

WHAT IS A 1031 EXCHANGE?


THE 1031 Exchange/Tax Deferred Exchanges


Doing a 1031 Exchange allows you to keep your tax dollars and put it down on another property

  • Investment Real Property are the only Properties that qualify for the 1031 Exchange

  • Why would you do a 1031 Exchange? To defer Taxes


What Taxes are deferred?


Capital Gains

• Short Term- 1 Year or less-Profit is taxed as ordinary income

• Long Term- 1 Year or more- 15% Tax Rate for individuals under $400,000 and couples under 450,000 §


State Capital Gain

  • Short Term- 5.04%

  • Long Term -4.45%

Recapture of Depreciation

  • If you have a property to which you have improved, you are taxed at a recapture rate of 25%

3.8% Net Investment Income Tax (Changes Per Location of Property)

  • Began Jan 1st, 2013

  • Will affect “high-earners”

  • Individuals who have an adjusted gross income higher than $200,000

  • Married couples with an adjusted gross income higher than $250,000

* The only other way to defer taxes is death




TAX REFORM


  • They are talking about increasing the top bracket from 37% to 39.6%

  • Currently, Capital Gains are 15-20% and there is a proposal to increase this to 39.6% analysts say this will affect .3% of the population

  • The Biden Admin has proposed a cap on the amount of gain that can be deferred through a 1031 Exchange at $500,000.




Per National Association of Realtors

  • 12% is the number of transactions that were part of a 1031 exchange from 2016-2019

  • 61% of realtors had a least 1 1031 exchange transaction from 2016-2019

  • Approx. 10-20% of all commercial Real Estate transactions involve a 1031 exchange

  • Eliminating the like-kind exchanges would create a lock-in effect resulting in fewer transactions and price declines



What does not qualify for a 1031 Exchange


Your Personal Use Property

  • If it was never an investment on your taxes it does not qualify for exchange

Stock in Trade Does Not Qualify

  • Flippers do not buy to hold or rent so they do not qualify

  • Developers build to sell, not build to hold so they do not qualify •

Stocks, Bonds, and Notes do Not Qualify


Interest in a Partnership Does Not Qualify

  • You and your friend own a property under an LLC, your friend wants to take the cash for exchange, you want to exchange to another property. Since the LLC owns the title, you must split the ownership on title. Often, people will do a quick claim on property and get their personal name or separate entity on title. •

Property must be in the US

  • Guam, Virgin Islands, and Norther Marina Islands are US

  • The purpose is to help the US economy

  • If you sell the property in another Country, the IRS will never know

  • If the investment property is in another country that is considered a foreign exchange and you must exchange to a property outside the US




Time Frames


Day 0 of Exchange to Closing of Relinquished Property

Day 1- Day after Closing- 45 Calendar days to Identify Replacement Property

  • You can identify up to three properties. Once the 45 days is over, qualified Exchange companies cannot help you purchase anything else

  • If you do not get any of your properties, the money sits in the exchange for 180 days until cycle ends

  • Day 180: Close on Replacement Property



Qualified Intermediary- Exchange Specialist

  • Security- How do they hold funds? How experienced are they? Be sure to interview all QI’s

  • Make sure they are reliable and can be reached by phone easily since these deals move fast

  • Regulations- some state require QI’s to be regulated. There is no federal regulation for QI’s



Delayed Exchange- Step by Step

  • Taxpayer retains services of independent tax advisor

  • Taxpayer enters into agreement to sell property, including recital that Taxpayer intends to relinquish property as part of a 1031 Tax Deferred Exchange

  • Open Escrow/Open 1031 Exchange

  • Taxpayer enters into Exchange Agreement with QI which becomes a principle in each transaction, not an agent

  • The first half of the exchange will close and then the time periods will begin

  • Taxpayer identifies Replacement Property or properties on or before the 45th day

  • 3 Property Rule- you can identify up to three properties no matter their value, but you cannot identify more than three

  • 200% Rule- any number of properties having aggregate value not more than 200% of Relinquished Property

  • 95% Exception- No rules no limits but there is a catch…you must purchase 95% of what you identify

  • Identification Form is filled out with QI once three properties are chosen. This form can be revised until the 45-day deadline

  • Taxpayer enters into agreement to acquire Replacement Property, including recital that Taxpayer intends to acquire property as part of a 1031 Exchange

  • Open Escrow/ Call 1031 Exchange

  • Exchange closes with the acquisition of the Replacement Property- or in stages if multiple properties are involved- all within 180 days

Title Parking Exchanges

  • Reverse Exchange- Client wants to buy and then sell (much more expensive due to liability for the QI’s holding title)

  • Improvement Exchanges- QI holds title and makes approved improvements


Hopefully, you now have a better understanding of what and why you would consider a 1031 exchange.


***We do not give tax advice, so please be sure to speak to your tax specialists for more advice on how a 1031 exchange might benefit your situation and then give me a call when the time comes to locate a property that will work for you in Ventura County, CA

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