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The Crested Butte area offers many possibilities for 1031 Exchange transactions. We have experience assisting 1031 Exchange clients and would welcome the opportunity to assist you with your sale and/or purchase.
Tax Deferred Real Estate Exchange
This page is intended to provide useful information about tax deferred exchanges of real estate held for investment. There are considerations of time and property value, so check with your tax advisor.
What is a 1031 Exchange?
A 1031 Exchange is a tax deferred exchange of investment property. The sale of some currently owned investment property is matched, or exceeded, in value by the purchase of similar investment property within IRS time and value guidelines. In the realm of real estate, the "exchange" means that the sale of one piece of investment property will be matched with the purchase of another "like" piece of investment property within the prescribed time period without any capital gains and therefore the individual will "defer" taxes.
Is This A Good Idea?
In most cases it is a great idea because if offers real estate investors one of the last great investment opportunities to build wealth and defer taxes. By using the 1031 Exchange, the investor can sell their current investment property and use all the proceeds to purchase the replacement investment property. Capital gains taxes are deferred and the investor leverages ALL of their equity into the replacement property. Whether it is a good idea for you should be determined only after a review with your tax advisor.
Hypothetical Example
With Traditional Tax Handling
Gain on sale of current property - $300,000
Taxes (at 33% rate) - $100,000
Net Gain - $200,000
Value of new purchase (with 80:20 loan) - $1,000,000
With a 1031 Exchange
Gain on sale of current property - $300,000
Taxes - $0
Net Gain - $300,000
Value of new purchase (with 80:20 loan) - $1,500,000
What are the requirements?
There are two basic requirements that must be met to defer the capital gains tax: (1) you must acquire like-kind replacement property (the new purchase must be of equal or greater value) and (2) you must reinvest all net equity (you cannot receive cash or other benefits from the sale of the original property, all proceeds must go towards the new investment). To quote the tax code: "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment purposes if such property is exchanged solely for property of a like-kind which is to be held for either productive use in trade or business or for investment purposes".
Who Should Use This Tax Deferring Instrument?
Anyone who is considering the sale of one piece of investment property and the purchase of another.
What Are The Identification Requirements?
You must identify the property to be received within 45 days after the date you transfer the property given up in the exchange. Any property received during that time is considered to have been identified. You must identify the replacement property in a signed written document and deliver it to the other person involved in the exchange. You must clearly describe the replacement property in the written document. You can identify the larger of (1) three properties or (2) any number of properties whose fair market value (FMV) at the end of the identification period is not more than double the total FMV, on the date of transfer, of all properties you give up.
What Are The Receipt Requirements?
The property must be received by the earlier of
- The 180th day after the date on which you transfer the property given up in the exchange, or
- The due date, including extensions, for your tax return for the tax year in which the transfer of the property given up occurs.
What Are Examples of Qualifying Property?
In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Machinery, buildings, land, trucks and rental houses are examples of property that may qualify.
What Are Examples of Non-Qualifying Property?
- Property you use for personal purposes, such as your home and your family car.
- Stock in trade or other property held primarily for sale, such as inventories, raw materials and real estate held by dealers.
- Stocks, bonds, notes or other securities or evidences of indebtedness, such as accounts receivable.
- Partnership interests.
- Certificates of trust or beneficial interest.
Will The 1031 Exchange Apply To Investment Property In Crested Butte and Gunnison area?
If you are selling rental property somewhere and want to purchase property in a resort community and use it as rental property, this is considered a like-kind exchange. You can review the trend in property values for the recent past in the Crested Butte and Gunnison by checking out my Market Reports at this website.
Tips for Mastering 1031 Exchanges
Why bother becoming an expert on 1031 exchanges? For starters, using a like-kind exchange instead of selling the property outright will almost certainly save your seller big bucks in taxes.
In addition, 1031 exchanges are a great estate-planning tool because heirs can receive a stepped-up basis and have any deferred taxes on the property forgiven by the Internal Revenue Service.
As the name implies, like-kind exchanges must be of similar property, so a sofa or other furnishings in a condo held for investment and rented out couldn’t be counted as part of the property value when it’s exchanged since furnishings are personal property.
If the personal property is valuable enough, you can do a separate exchange for other personal property, but if it’s just a small amount, take the value of the furnishings as a boot and pay the taxes on it.
What’s the Boot?
The term “boot” refers to any non-like-kind property that is exchanged. Boot, which is most often in the form of cash, can result when the value of the piece of real property being relinquished is greater than the value being acquired.
Receiving a boot in a like-kind exchange doesn’t disqualify the exchange, it only introduces a taxable gain to the transaction. Only the gain that results from cash and unlike property is taxable.
These amounts cannot exceed the amount of the gain recognized if the property was sold in a taxable transaction.
How to Calculate the Gain
To calculate taxable gain, a property seller should begin with the price of the relinquished property and then subtract the adjusted basis of the property. This amount is the realized gain.
The adjusted basis is the purchase price of the relinquished property plus any capital improvements to the property, less any depreciation.
The basis amount carries over to become the basis of the replacement property.
While 1031 exchanges cannot be used for residential property that is used as a primary residence or a vacation home that is used by the owners for more than 14 days per year, it provides a great strategy for deferring taxes on highly depreciated properties.
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