Common 1031 Exchange Myths Dispelled
You may have heard talk about 1031 Exchanges, and how they can potentially save you big money at tax time. That is true, but the rules governing 1031 Exchanges are very complicated. Unfortunately, there are a few myths floating around and occasionally people are led to make bad decisions because they believed in them.
Before you attempt a 1031 Exchange, it’s best to consult with an experienced and knowledgeable accommodator. The attorneys of Larson & Solecki LLP can help you find one, if you need assistance. In the meantime, watch out for these common myths and avoid making major decisions until you seek expert advice.
You can use a 1031 to trade up homes. While a 1031 Exchange is often used for real estate transactions, it is reserved for investment properties only. Unfortunately, you cannot utilize the tax benefits of a 1031 just to sell your personal residence and purchase another. There is one portion of the regulation that might allow you to swap vacation homes, but it’s a very tricky exchange and requires the guidance of someone knowledgeable in handling exchanges.
A 1031 Exchange is only used for real estate transactions. While they are perhaps most commonly associated with real estate investments, a 1031 Exchange can actually be used for certain other types of investment property. For example, investments in property such as art commonly qualify. You cannot utilize this type of exchange on investments such as stock or partnership interests, however.
As long as the exchange of property occurred within the year for which you are filing taxes, it qualifies. Actually, you have exactly 180 days (six months) to close on the new property after selling the first one. You also must designate the replacement property, in writing, to the intermediary within 45 days of closing on the sold property. These time lines run at the same time, meaning if you designate a new property 40 days later, then you have 140 days left to close on the new one.
As long as you don’t receive cash from the sale, you won’t be taxed. A change in mortgage liability can be taxed, usually as a capital gain. For example, if you had a mortgage of 500,000 on the sold property, and you’ve exchanged it for a property with a 450,000 dollar mortgage, the lowering of your liability by 50,000 dollars is treated as a profit. You will be taxed for that 50,000 dollars – probably as a capital gain.
As with all tax situations, always seek advice from your tax advisor before attempting a complicated maneuver, and from an experience exchange accommodator if you are attempting a 1031 Exchange. What you may have heard about 1031 Exchanges or any other tax situation may not be true. Seek guidance before attempting the transaction, so that when you file your taxes the following year there are no surprises.