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.
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.
Our latest guest blog is live. Visit Bigger Pockets to learn how you can accelerate your real estate investing using your primary residence.
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 […]
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.
- You can stay together as one 1031 Exchange or
- You can 1031 Exchange your portion while the other(s) to take cash or
- 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.
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.
Does it matter if you use a local or national 1031 Exchange Qualified Intermediary (QI)? Wouldn’t it be better to select someone you can meet in person? While some investors derive a sense of comfort from proximity, the closest QI may not be the right QI.
To carry out a 1031 Exchange, your QI must be in place before you sell your investment property. The geographic location of your QI is not a critical factor for either documentation preparation or real estate closings.
But what of your peace of mind? These are your hard-earned investment dollars we’re talking about.
No matter their physical location, your QI should be experienced, accessible and dependable. They should be able to guide you through the exchange process and help your exchange glide smoothly along. They should be responsive to inquiries and timely in their communication.
If you are buying and selling within your home city, a local QI should be familiar with that market. However, a well-versed national 1031 Exchange Qualified Intermediary may be better suited to help you carry out an exchange both locally and from state to state. Regardless, a QI with a significant history of successful exchanges may serve you better than one with the ability to drop by for a cup of coffee.
No matter what your preference, to qualify for a 1031 Exchange you must have your local or national QI in place prior to the sale of your investment property.
For more information visit the www.1031investor.com.