Let’s say John purchased an apartment complex almost 30 years ago for $100,000 in a growing part of town and has maintained the property in great condition. Today it appraises for $2 million, is fully depreciated and after expenses, cash flows $36,000 per year. It is fully paid for and he has no mortgage interest deduction. John’s rate of return on his $2 million property is only 1.8 %. John wakes up one day and says to himself, “I think I can get a better rate of return – I would like to get an 8-10% return on my investment”. Guess what John is RIGHT! Then John says but if I sell I will pay a huge capital gains tax. Guess what, John is WRONG!!!
I am amazed at how many investors like John or those who want to be an investor know little or nothing about the Internal Revenue Code #1031 Exchange designed to defer federal capital gain taxes from the sale of investments. With the capital gain rate rising from the 15% of recent history to 20% and probably well beyond, many investors like John are reluctant to sell because of the tax consequence. In this example if $100,000 is John’s basis his gain would be $1.9 million. Even with a 20% capital gains tax his tax bill would be $380,000. With an IRS 1031 Exchange his tax bill would be “ZERO”, provided he meets certain minimal requirements. While it is still available this remains an investor dream come true.
I have brokered a number of 1031 Tax Deferred Exchange properties, which involved a buyer, a seller or both. The following will begin a discussion of the requirements for a 1031 Tax Deferred Exchange:
1) “LIKE KIND” PROPERTY Many investors are confused by the term 1031 “Like-Kind” Exchange. The term does not mean what we commonly take it to mean. In the example, John could sell his apartment complex and buy timberland, farm land, a commercial building or any other type of real estate as long as it is not his primary residence.
2) SAME TAXPAYER REQUIREMENT If the property is owned by an investment group or partnership then the same sellers must purchase the replacement property. There are 2 exceptions: 1. a single member LLC may sell and acquire the new property in his name or a new LLC and 2. A revocable trust may sell in the name of the revocable trust and purchase the replacement property in the same name.
3) FULLY DEFERRED EXCHANGE If the owner is to receive a deferral of all his gain it must meet 3 requirements: 1. The new property must be equal to or greater than the value of the sold property, 2. Reinvest all the equity in the sold property into the new property, 3. Acquire only “like kind” property (real estate for real estate).
Published in Ouachita Citizen on January 10, 2019