Big Tax Savings through Tax Deferred Exchanges - aka Like Kind or 1031 Exchange

Often clients find themselves in an uncomfortable situation after selling a piece of property that has appreciated in value.

Q: I have some rental real estate to sell that has greatly appreciated over the years. I really do not want all my gain eaten up by capital gains tax. What are my options?

A: One option to look at is using a 1031 tax exchange to unload the property. You would have to consider another piece of real estate to replace it through a like kind exchange. The tax savings can be huge over the long run.

Q: If I am selling a rental apartment, do I have to purchase another rental apartment in place of it? I really want to retire from rental activities.

A: No, any kind of real estate could be used, including a piece of land. This has an obvious plus to it if you are planning to say, build a new commercial site. There are, however, other requirements to meet including a contract that mentions that the buyer and seller intend to cooperate in a 1031 transaction.

Q: How soon do I have to convert to a new property?

A: You have until the end of the 45th day from the close of the sale of your property to identify up to three properties as potential buys. The transfer of the chosen property must occur within 180 days of the transfer of the relinquished property. However, this period is shortened if the due date of the tax return for the year of the exchange, including extensions, is shorter than this 180 day period. Then the due date of the return is the deadline to shoot for.

Q: What do I do with the money I received from the original sale until I transfer it into the new property?

A: You should never touch any money in this type of transaction. An Intermediary will hold the funds for you and take care of the paperwork necessary to accomplish the exchange. There is a cost associated with these services, but the tax savings may well be worth the additional costs.

Q: Can I sell the replacement property right away and recoup my money?

A: No, you must be willing to hold the replacement property at least one full year. The taxes you save will reduce the cost basis of the replacement property.

Q: Can I use this option to sell personal property I have held as an investment?

A: Yes, but the property you replace it with must also be held for an investment or business purpose. You can never use a like kind exchange for property held for personal use. You can however, use it to defer a cash exchange into another tax year if the 45 day period would end in the next year and you fail to name a replacement property. The cash would become yours in the new tax year and you would be taxed in that year and not the previous. This provides a timing difference that may be a benefit to consider in a year in which you are going to retire from a rental activity.

Q: I am considering a like kind exchange with my cousin. Can I still do this even if we are related?

A: Yes, but there are definite rules regarding who is and who is not a related party for these types of transactions. Related party transactions increase the holding period of a replacement property to two full years. This is an important consideration. You may wish to use your brother-in-law as the contracting party instead of your sister, for example, to avoid this pitfall.

Q: The like kind exchange sounds like a great opportunity to reap the benefits of the tax laws. Can I use it in my situation?

A: There are six different and unique requirements that must be met in any like kind exchange. I strongly urge you to seek professional help when considering this alternative. You do not want to find out later that your transaction did not qualify for this treatment and be faced with the costly consequences. The six inter related requirements are not difficult to meet, but you must be sure that you have, in fact, met them. Assuring this type of exchange occurred is imperative if your tax planning is to be considered effective.

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