Protect Your 1031 Exchange – File for an Extension

If your 1031 exchange began in late 2019, you may need to file for an extension of your tax deadline. This is because the normal exchange period of 180 days will be shortened to your tax filing day (April 15th with out an extension) if your surrendered property closed between October 19th and December 31st, 2019. Therefore, it is important to remember to file for an extension in order to protect your complete 180-day 1031 exchange period.

Why does this happen? The regulations outlined in Section 1031 state, “The exchange period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the earlier of the 180th day thereafter or the due date (including extensions) for the taxpayer’s return of tax imposed by chapter 1 of subtitle A of the Code for the taxable year in which the transfer of the relinquished property occurs.”

To explain this a little better, your normal 180-day exchange period can be reduced if you began your 1031 exchange after October 19th, 2019. If you are unable to purchase a like-kind replacement property before the deadline of April 15th, you should consider filing a tax extension in order to allow yourself the full 180 days.

How this Works

For example, Mr. Jones sells Vista Apartment Complex as part of a 1031 Exchange on November 26, 2019. Although the 180th day after this sale of his relinquished property is May 24, 2020 – his tax filing deadline occurs before this and automatically becomes his 1031 Exchange deadline as well. By filing an extension to his tax return, Mr. Jones can extend both his tax filing deadline and revert his 1031 Exchange deadline to the full 180-day exchange period.

Therefore, if your relinquished property closed between October 19th and December 31st, 2019, it’s important to file for an extension on or by April 15th, 2020. This will ensure you don’t lose out on your full 180-day 1031 exchange period.

Resources

To determine if the exchange you initiated in 2019 has a 180 day deadline after April 15th, use my 1031 exchange deadline calculator at The 1031 Investor.

To get more information about how to file for an extension, check out the IRS website for complete instructions.

A Consolidation 1031 Exchange and Why You Need It

If you have several different investment properties, it may be beneficial for you to sell them and invest in a larger property with a consolidation 1031 exchange. If you have been focusing on single family rentals, for example, you may own quite a few smaller properties. But, this can leave you spread over a large area trying to maintain multiple locations. What if you could exchange all of those properties for one large unit such as an office building? The good news is, with consolidation 1031 exchanges, you can!

What is a Consolidation 1031 Exchange?

To put it simply, a consolidation 1031 exchange starts with the sale of investment real estate and ends with the purchase of investment real estate. As long as the property valuations work out, consolidation 1031 exchanges allow you to sell multiple units and combine their value into a larger purchase.

For example, if you have four single-family homes selling for $250,000 each, they could be sold and combined to purchase a property worth $1 million. This does require additional planning as the timing of your sales and replacement purchase must fall within the IRS mandated time frames. Coordinating extended and/or rapid closings with your purchasers and entering into a contract on your replacement property may require extra effort and negotiation.

Why do I need a Consolidation Exchange?

One of the main benefits of using a consolidation 1031 exchange is the deferment of taxes. Typically, when you sell your investment property, any gain is subject to taxation. Also, whether or not you took advantage of the available depreciation deductions while you owned the property, you will still be subject to “depreciation recapture” taxes. However, this is not the case when using a 1031 exchange.

Consolidation 1031 Exchange Example

Some clients of mine recently completed a consolidation 1031 exchange. They sold three properties in the Midwest and replaced them with one higher value vacation rental property in California. First, they identified both their replacement property. Then, they found a purchaser for all three of their original rentals. Then they sold the three original rentals over the course of three weeks. They purchased their replacement property just three weeks later. Not all transactions will happen as neatly or swiftly as theirs, but it is an indication of what advance planning can accomplish.

Consolidation Can Add Up

When you use a consolidation 1031 exchange, you can sell your investment real estate and purchase replacement investment real estate while indefinitely deferring payment of the tax that would normally be due on the sale. This can significantly increase your buying power as well as your opportunities for compound growth and reinvestment.

New Yorkers Are Fleeing High Taxes and Moving to Florida

Aside from the obvious benefits of having year-round sunshine and beach access, Florida also has the benefit of being a very tax-friendly state. With no income tax and waterfront views at a lower price, it is easy to see why New Yorkers are fleeing the frozen north. According to Businessinsider.com, millionaires from New York can save more than one million in taxes by relocating to Florida. In fact, mansion sales are on the rise in Florida. Florida has certainly come out quite nicely as a result of the recent tax cuts.

3 Myths That Haunt 1031 Exchanges

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Think tax-deferred 1031 Exchanges of real estate are too new, sketchy or scary to try? Every week, I talk to investors just like you who are surprised to learn that:

  • 1. 1031 Exchanges have been around longer than IRAs and 401(k)s;
  • 2. 1031 Exchanges are 100% legal; and,
  • 3. 1031 Exchanges can be completed by novice investors.

Here are some myths I confront every day:

Myth #1: 1031 Exchanges Are Too New To Be Trusted

In 1921, Congress enacted The Revenue Act which authorized the exchange of like-kind property without paying tax. It was added to the Internal Revenue Code (IRC) Section 1031 and “1031 Exchanges” were born.

These transactions were originally used by cash-poor farmers to allow for the “exchange” of investment real estate without paying tax on the gain. In the intervening 98 years, IRC 1031 rules and regulations have evolved to serve today’s real estate investors. As we approach the 100th anniversary of 1031 Exchanges, the myth of their novelty should be retired.

Myth #2: 1031 Exchanges Are Sketchy

1031 Exchanges are not a “tax loophole”. Like your 401k or IRA, the tax deferral benefits of a 1031 Exchange are government endorsed and sponsored. As times have changed, the ways in which 1031 Exchanges can be successfully conducted have been both clarified and refined. Your 1031 Exchange qualified intermediary can guide you through the specific steps of this legal transaction.

Myth #3: 1031 Exchanges Are Scary

Most investors I talk to tend to be annoyed by the restrictions imposed on their IRA or 401(k) rather than fearful of the tax-deferred retirement provisions in the law. Same with 1031 Exchanges – there are specific rules and regulations. Some of these are maddening and some of them are pesky, but millions of investors have navigated them successfully. If you have never completed a 1031 Exchange, don’t be put off or intimidated by unfamiliarity.

In the course of your real estate investing career, you may find yourself selling your appreciated or depreciated investment real estate and purchasing replacement investment real estate. Why not keep your taxes working for you in that transaction? Follow the 1031 Exchange rules and regulations and you can indefinitely defer payment of the tax that would normally be due on sale and grow your portfolio using Uncle Sam’s money. Its time tested, legal and entirely within your capabilities.

Myth busted!

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Why You Should Rent – Not Sell – Your Home

Our latest guest blog is live. Visit Bigger Pockets to learn how you can accelerate your real estate investing using your primary residence.

Do I Need An Attorney For A 1031 Exchange?

Do I Need An Attorney For A 1031 Exchange?

The IRS statute requires that you use a qualified intermediary (QI) to perform your 1031 exchange. While it is possible for an attorney to provide this service, it doesn’t have to be an attorney and it can’t be an attorney you have utilized for any other matters. This is because the IRS statute also requires […]

Airbnb and 1031 Exchanges

Discover how 1031 Exchanges can be used to keep the tax on your TIC working for you!

What To Do With Your Slice Of The Pie: 1031 Exchanges And Tenants In Common (TICs)

Tenants In Common (TIC) is a wonderful little arrangement wherein multiple owners each have a deeded interest in a property. That interest is a percentage or portion of the property. But can investors who hold an investment as Tenant in Common still take advantage of a tax deferred 1031 Exchange?

Long answer short: YES! When you sell your TIC, you can each decide what you want to do with your slice of the pie.

  1. You can stay together as one 1031 Exchange or
  2. You can 1031 Exchange your portion while the other(s) to take cash or
  3. You can each do a 1031 Exchange into separate properties with your portion.

You’ve got great flexibility in how you transition out of a property held as tenants in common. Because each situation and investor has unique circumstances, always consult with your financial adviser before proceeding.

1031 Exchanges and Conversion Into a Primary Residence

Many people know about the primary residence exclusion that allows them to take the first $250,000 in profit ($500,000 if you’re married) tax free after just two years of occupancy. And more and more people are learning about the opportunity to do that repeatedly. But, did you know that you can convert an investment property into your primary residence and take advantage of that tax break? Even if you used a 1031 Exchange into your investment property, it’s still an option.

Converting from Investment to Primary Residence

Here’s the deal on converting investment property into your primary residence:

  • If you purchased the investment without a 1031 Exchange, you may change its use at any time. Simply use the property as your primary residence for two of the five years immediately preceding its sale.
  • If you purchased the property with a 1031 Exchange, there are some special rules for the conversion and the exclusion is prorated.

Converting after a 1031 Exchange

As you may recall, you cannot use a 1031 Exchange to purchase a property you intend to use for your primary residence. You must use the 1031 to purchase property you intend to use for investment purposes.

However, you can convert a 1031 property into your primary residence after holding it for productive use in business or trade for a period of time. The key is:

  • your initial intent to hold it for investment purposes and
  • how you demonstrate that intent.

For example, if you 1031 into a property and then move right in, what was your demonstrated intent? To use it as your primary residence. Both your initial stated intent and your actions subsequent to purchase are key.

Special Rules after a 1031 Exchange

If you 1031 into a property and then use it as a rental for the next 24 months and do not use it for personal use more than 2 weeks or 10% of the number of days it is actually rented, then the IRS gives you a safe harbor and will never challenge your initial intent. In between day one and two years, there is a wide range of time for you to decide if you’ve owned it long enough and treated it as investment enough that you can change your intent and move in. An awful lot of folks feel good at anything more than a year. But, individual circumstances could allow a shorter (or longer) investment use period.

When you do convert the property into your primary residence, you will then get the benefit of the primary residence exclusion with some 1031 Exchange specific requirements.To qualify for any of the primary residence exclusion, you must have owned the converted property for no less than five years. In addition, you must have lived in it for two out of the five years prior to sale. And then you get to prorate the amount of gain between the period of “qualified use” (as a primary and tax-free) and “non-qualified use” (as an investment and you would pay tax on this portion). You also have to recapture all depreciation.

The Bottom Line

The conversion of an investment property into a your primary residence is an underutilized option that can be very beneficial. Over time, it can make the capital gains tax on your former investment property dwindle. This give you the opportunity to take all or a portion of your home sale proceeds tax-free.

 

As always, consult with your accountant to determine the best course of action for your financial situation.