Over the next few posts, I will be dispelling many of the common myths surrounding 1031 exchanges. The confusion and misunderstandings caused by the myths has resulted in many taxpayers paying more taxes than they should. By paying the excess taxes, the non-exchangers have reduced the amount that they can reinvest, thereby needlessly reducing their income.
Myth No. 1
I sold a single-family rental property, thus I must buy a single-family rental property.
Alexandra and I hear this all the time. Similarly, we hear “I can only trade raw land for raw land” or “multi-family for multi-family” or “Massachusetts property for Massachusetts property.” In actuality, Section 1031 requires an exchange of “like-kind” property. When dealing with real estate, “like-kind” is defined as any interest in real property. Therefore, an exchanger can trade a single-family rental property for a commercial building. Raw land can be exchanged for developed land. Massachusetts real estate can be exchanged for Florida real estate.
Fractional interests can be exchanged for fee simple (or undivided) interests. Likewise, fee simple interests can be exchanged for tenants-in-common interests. Often times we see exchangers selling fee simple interests in Rhode Island property and buying TICs in other states.
Conservation easements, development rights, air rights and other intangible real estate rights can qualify as real property and be exchanged for fee simple interests, TICs and other real estate investments.
In summary, real estate is broadly defined. Tax courts look to local law in determining if an interest is “real property”. If the interest is real property, then the exchanger has a very wide array of options
Myth No. 2
My property is not worth enough for the trouble of a 1031 exchange.
Nothing could be further from the truth. First of all, 1031 exchanges are very easy, especially with All States 1031 Exchange Facilitator, LLC. We handle all the paperwork to satisfy the stringent requirements of the IRS and hold your hand throughout the entire process. Our experience and knowledge of the tax law and the 1031 exchange process allows us to simply everything for you.
Second, the key in determining the value of the 1031 exchange is to look at the amount of taxes that will be deferred, not the selling price of the relinquished property. The amount of the tax that will be deferred is based on the amount of gain that will be recognized if you do not complete an exchange. Your CPA or other tax return preparer can help you with the exact calculation or use our capital gains calculator to determine an estimate of your tax. In any event, even for a low selling price, a taxpayer who has owned the property for many years or who otherwise has a low adjusted tax basis may be staring at a large tax bill. the other component of determining your tax is the tax rate. The federal long-term capital gains rate is currently 15%. However, under several proposals, this rate could increase to 20%, 28% or higher. Don’t forget that any depreciation you have taken gets taxed at 25% currently. And, for some of you, various states will impose taxes. For example, Rhode Island just increased its tax on long-term capital gains from 1.67% to 9.9%. By exchanging real estate in a 1031 exchange, all of these taxes can be deferred, and the tax money reinvested in your new property.
So, even a relatively low selling price of $300,000 by a person with an adjusted tax basis of $100,000 could result in a tax of over $50,000. Instead of sending that money to the government, why not reinvest it and reap the rewards of the larger investment?
In summary, understand the facts of 1031 exchanges and don’t fall for these common myths. You will save money in the long-run and be a smarter investor.
Check back for more posts dispelling other myths about 1031 exchanges. In the meantime, click here for more 1031 myths or contact me or Alexandra Hart at 877-395-1031 or by e-mail fmm@allstates1031.com or ahart@allstates1031.com.
Tags: 1031, 1031 exchange, alexandra hart, All States, capital gains tax, Certified Exchange Specialist, CES, conservation easements, development rights, FEA, Federation of Exchange Accommodators, investment, investment property, IRS, like kind, Moore McLaughlin, myth, QI, qualified intermediary, real estate, real property, Tenant In Common, TIC