This is the time of the year when many business and home owners are hunkered over receipts with an accountant, fervently attempting to make sure their own balance sheet somehow works out for their favor. A 1031 exchange is an element that many don't know a whole lot about, and while it is a bit precarious, is still used to many folks' advantage. In effect, you can change what form your investment exists in, without cashing out on it, or recognizing a capital gain. This allows your investment to continue to benefit you, while it is still considered tax deferred. There are no limits on frequency and how many times you do a 1031, and you can roll over the gain from one piece of investment real estate to multiple others if you wish.
The most important thing that CPA's and attorneys want the individual in question to know is that special rules apply when depreciable property is at question in a 1031 exchange. If you are swapping one building for another building, you can avoid this specific recapture, but when improved land is in question, things change a bit. If improved land is exchanged for a building for unimproved land without a building, the previously claimed depreciation will be recaptured under the guise of ordinary income. Here are some of the most important things you need to know about this type of swap, and tips to help you through this wintry time when all of these issues are important.
This is not for personal use: This provision is strictly for investment and business property, so swapping homes is not an option.
Some Personal property may be fair game: Most 1031 exchanges are of real estate, but there are some exchanges of personal property that can qualify. Exchanges of interests as a tenant in common sometimes do qualify.
Some terms can be broad: Most exchanges can be merely made of “like-kind”, which in some ways is not as literal a description as you'd think. You an exchange a farming ranch for a strip mall, which is a bit of a surprise given the terms at hand. You are able to exchange one business for another, but there are pitfalls for those not paying attention.
Information on “delayed” exchange: In most cases, an exchange involves a property swap for another that is actually between two people. Since the odds of finding someone with the exact property you want may be slim, many exchanges fall under the guise of delayed. In this type of exchange, you need a middleman who will hold the cash after you sell the property, and use it to in essence purchase the replacement property for you.
Designating replacement property is a must: When an exchange is delayed, one of the rules of timing is that the intermediary will actually receive said cash. You don't receive the cash yourself, or it spoils the conditions for a 1031 exchange. Within 45 days of the property's sale, you need to designate which property is replacement status in writing to the intermediary, specifying the property you are desiring to acquire.
Multiple replacement properties can be designated: There has long been debate about how many properties you are actually able to designate, and what kind of conditions that you are able to abide by. After valuation tests, you can designate more properties. One example is that you can designate a virtually unlimited number of replacement properties, as long as they do not exceed 200% of the aggregate fair market value of the collective properties being looked at.
Closing needs to take place within 6 months: The new property in question much be closed on within 180 days of the old, and the countdown begins when the sale closes. If you designate replacement property exactly 45 days later, at that interval you will have 135 days left to close on it. The most important thing to note here is that the two time periods run concurrently.
If cash is received, it is absolutely taxed.
There may be cash left over after the intermediary is finished with the acquisition of the replacement property. If this is the case, it will be paid to you at the end of the 180 day period. The term for this cash is “boot”, and it will be taxed as partial sales proceeds as a capital gain would.
Using 1031 for a vacation house is tricky. You can sell your primary residence, and being combined with a spouse, protect $500,000 in capital gain. The stipulation is that you need to have lived there for two years out of the past five. This break isn't available for a second home, or vacation home. Taxpayers are still able to turn vacation homes into rental properties and do the 1031 exchange, especially if you convert the property's use.
During 2008, the IRS set forth a safe harbor rule, in which it said they would not challenge whether a replacement dwelling qualifies for an investment property. In order to meet that safe harbor, it must be rented for 14 days or longer, and your own personal use of the dwelling unit needs to be limited to two weeks.
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