Why this tax deferment tool may soon be on the rise
We have a sneaky suspicion that 1031 exchanges will be increasing in popularity over the coming years (you read it here first, folks smile). Before we dive into explaining what a 1031 actually is, let’s take a look at the capital gains backdrop that’s leading us to our prediction. As the law stands now, the long-term capital gains tax is set to rise from 15% today to 20% next year. Further, there is much talk that Obama would prefer increasing it to 24% or even higher over the coming years, to shore up the government’s revenue base.
If you believe, as we do, that taxes have nowhere to go but up (barring any unexpected shift in our government’s behavior), then 1031 exchanges should pique your interest. Section 1031 of the Internal Revenue Code defers any tax consequences around the sale of a property. The conditions are:
- The property sold must be an investment property not a primary home.
- The new property needs to be “like-kind” and of equal or greater value to gain the full benefit.
- The new property must be identified within 45 days of closing on the existing property.
- The new purchase must be made within 180 days of the said sale.
- All of the sale proceeds (held in escrow until the time of the new purchase) must be used towards the purchase of the new property.
- The initial sales contract must designate the property sold as a 1031 tax exchange candidate.
Many investors already use the 1031 exchange to defer their tax payments and effectively create leverage. By deploying funds that would otherwise go to taxes towards the purchase of another property, they magnify its return potential.
Now that capital gains taxes are on their way up, we believe that 1031 activity will follow suit. If you are looking to sell your investment property in the next few years, don’t overlook these 1031 conditions in your planning.
{ 3 comments… read them below or add one }
Interesting. I heard this tax-avoidance vehicle was all the rage when people were flipping properties. Anyway, I have a question, since this is something I will be doing in about 1.5 years. I will be selling my investment property (prior primary home) to buy in NYC. My understanding is that I can incorporate, have the corporate entity buy the property, from which I will “rent.” Is this true? What is the stance of co-op boards to the idea of a corporation buying shares?
Hi ISLM,
You ask interesting and complex questions, leading me to first note the following disclaimer: we are not in a position to offer tax or legal advice, and please do not take the following as such.
Now, buying a co-op as an investment property, particularly via the very technical 1031 exchange, is generally not advisable on a number of different levels. First, most co-ops have restricted subletting policies, if allowable at all. Second, their boards almost never allow title to be held by a corporation or by a LLC; trusts are sometimes possible, depending on the co-op. When someone wants to do a 1031, therefore, it’s usually a condo. Trying to consummate a 1031 with coop shares can be like climbing Everest.
I would refer you to Ron Gitter at http://www.coopandcondo.com for actual legal advice, if you so wish. We tapped into his expertise to make sure we were not off base in terms of writing the above. I hope this helps.
This was well written, and if anyone was looking for “non-advice” reading, this is a must that they should read over and over. You are so right about the complexities of 1031′s and anyone contemplating one should invest the costs of a seasoned 1031 attorney or closer to make sure they do it right the first time. I have never heard of the IRS granting a “do-over or mulligan” if things are not done right at first.