Do you own some real estate with a huge gain that you would like to replace with different real estate? (Maybe closer to you? Maybe in a more desirable neighborhood? Maybe in a different state or county?)
Normally, you would sell the undesired real estate, pay the tax on the gain, and invest the net after-tax proceeds in a new real estate holding.
There is an alternative. It’s called a “Section 1031 Exchange.” Basically, if you follow the rules, you could end up selling one property, purchasing a different property and not have to pay any Capital Gains tax at the time of the exchange.
What are the rules you ask? Well for one, the property you are buying must be more expensive than the property you are selling. You cannot walk away with any cash after the deal is done (that would be taxed). The debt on the new property must be equal to or greater than the debt on the property you are selling (if new debt is less, that will trigger a tax).
You can NOT touch any of the proceeds from the sale of the old property. You must use what is called a “Facilitator.” (And they charge a fee for their services.) They handle all the proceeds from the old property and do the actual purchase of the new replacement property.
You must identify the replacement property within 45 days of the sale of the old property and the new property must be purchased (close of escrow) within 180 days of the sale of the old property. That is not that much time, so you have to move fast on finding and purchasing replacement property or the gain on the old property kicks in.
But wait there’s more. The basis of the new property is the basis of the old property plus any additional funds you had to put in for the purchase of the new property. That means low future depreciation expense if you are dealing with rentals. (Resulting in paying more income tax on the income from a rental.)
Also, whenever you decide to sell the replacement property and not do another Section 1031 exchange, the gain on the sale of the replacement property will be much larger. The gain you deferred with the original property now kicks into a taxable situation and is added to the gain on the replacement property.
The best way to avoid the tax on sale of exchanged property? Wait until one spouse dies. Current tax law allows for a step-up in basis to Fair Market Value at date of death of the first spouse. This involves some solid estate planning.
Did you hear? Prov 10:22 says, “The blessing of the Lord makes rich, and he adds no sorrows with it.”
Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 882-4459. On the web at BullisAndCo.com. Also on Facebook.
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