Everything You Need To Know About 1031 Exchanges In 2019

Navigating the tax code is a lengthy and tedious process - especially if you are unfamiliar with the code itself and how to identify potential benefits. One key benefit that those with investment properties can leverage is that of the 1031 exchange transaction. A 1031 exchange is a transaction that allows you to sell a rental or investment property and defer all capital gains taxes that would come on a sale by essentially reinvesting your would-be profits into another investment property. A 1031 exchange is not the ideal solution for every real estate transaction, but when it is, this particular type of transaction can save investors hundreds of thousands (or even millions) of dollars in taxes.

The tax code is regularly undergoing reviews and revisions. A 1031 exchange in 2019 is very different than what you would have experienced even a mere decade ago. As a CCIM-designated (Certified Commercial Investment Member) commercial real estate broker, Lowrey Burnett has facilitated his fair share of 1031 exchanges. With education being the cornerstone of business at Fountainhead Commercial, we want to share with you our guide to 1031 exchanges in 2019.

Save Big With A 1031 Exchange

Unless you’re a CPA or another type of professional whose job requires you to be intimately involved with the US IRS tax code, you likely don’t spend much time reading up on tax regulations. So, we’re going to scrap the legal jargon and tell you what you need to know about the restrictions, regulations, and taxes associated with selling a rental or investment property.

Capital Gains

In layman’s terms, capital gains are the profits you make on the sale of a rental or investment property. Calculating this is relatively simple, but requires a few separate figures:

Purchase price of property + Cost of capital improvements - Depreciation deductions taken during holding period = Adjusted basis in property
Sale price of property - Costs of Sale = Net proceeds
Net proceeds - Adjusted basis in property = Capital gains

Federal Capital Gains Tax

Your capital gains tax can be calculated easily once you have all the necessary figures.

Capital gains - Historical depreciation = The total amount to be taxed at your capital gains rate

Capital gains are taxed at 20% rate (or taxed at 0% or 15% depending on taxpayer’s income). Now, Federal capital gains taxes are not the only taxes you’ll need to consider when selling a property.

Federal Depreciation Recapture Tax

Selling a depreciable asset that results in a gain must be reported as income. As such, it is also taxed and typically at 25% tax rate. This total is your depreciation recapture tax.

NIIT (ObamaCare) Tax

The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code went into effect in 2013. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts.

State Income Tax

In addition, taxpayers have to pay state and local income taxes on their capital gains income from zero percent in states that do not levy an individual income tax to as high as 13.3 percent in California.

A general rule of thumb is to allocate as much as 30% for capital gains taxes in states such as Colorado and 40% in California.

Capital Gains Tax

Your capital gains tax can be calculated easily once you have all the necessary figures.

Capital gains - Historical depreciation = The total amount to be taxed at your capital gains rate (changes depending on marginal tax bracket)

You can see how these taxes would add up quickly and encourage rental and investment property owners to seek an alternative when they want to relinquish a piece of property.

So, You’d Rather See Returns On Those Taxable Gains?

We would, too! With a 1031 exchange, you can reinvest the money that would have otherwise disappeared into the hands of the IRS. In order to reap this benefit and defer all taxes, though, your 1031 exchange must adhere to a number of different requirements. Now, there are nuances that apply only to specialty exchanges. However, for simplicity’s sake, we’ll focus only on the basic 1031 exchange rules for this year.

The Language Of A 1031 Exchange

In a properly executed 1031 exchange, you’ll have two types of properties: a relinquished property(ies) and the replacement property(ies). These two types of properties must be of “like-kind.” As of 2019, the similarities required between “like-kind” investment or rental properties are more general than not. This gives property owners quite a bit of flexibility when it comes to what they can replace their relinquished property with.

The Requirements Of a 1031 Exchange

Now that we have the terminology of a 1031 exchange under our belts, we can move on to the specific requirements and nuances you’ll want to know when executing a 1031 exchange.

The replacement property must be of equal or greater value than the net sales price of the relinquished property.
All net sales proceeds must be reinvested to prevent capital gains taxes.
Any cash (aka ‘boot) taken out of the deal can be taxed up to the amount of the total realized gain.
When trading down debt on a property, know that the difference can be taxed (this is easily offset by adding the equivalent cash back into the deal).
You must have identified up to 3 replacement properties within 45 days of selling your relinquished property.
The total value of the replacement properties (if more than three are identified) must not exceed 200% of the value of the property sold. If it does, then 95% of what is identified must be purchased.
You must close on replacement property within 180 days of selling your relinquished property.
The same taxpayer name must appear on the tax return, relinquished property, and the replacement property.

While the requirements and restrictions of a 1031 exchange may seem straightforward, the process is quite complex and not something you want to enter into without the help of an experienced professional.

Finding A 1031 Exchange Expert To Help You Navigate The Process

As we mentioned previously, not every transaction is best suited for a 1031 exchange. If you’re wondering whether or not an exchange would make sense for your property, you’ll want to not only engage a commercial real estate broker, but also your CPA, real estate attorney, and Qualified Intermediary (Q.I.) to gain the expertise needed to make the right decision.

Your timeline is short - 45 days will fly by. You definitely want an experienced broker on your team from the very beginning to help you plan, organize, and orchestrate a 1031 exchange successfully. Look for a commercial broker who has handled 1031 exchanges before. Their previous experience will be the ultimate benefit to you as a property owner who wants to defer capital gains taxes.

Your Source For 1031 Exchange Expertise

At Fountainhead Commercial, we’ve helped business and property owners navigate all types of commercial real estate transactions, including 1031 exchanges. Our CCIM-designated commercial real estate broker can help you avoid expensive mistakes by guiding you through the strict timeline and restrictions of a 1031 exchange, helping you defer capital gains taxes and reinvest for higher returns.

If you have a rental or investment property that you’re considering relinquishing, contact Fountainhead Commercial’s 1031 exchange expert today to see if you should be deferring capital gains taxes.