What’s Old is New Again: Section 1031 Exchanges on the Rebound

December 23, 2013|Kenneth Zacharias

In 2013, we have seen a significant uptick in use of the Internal Revenue Code Section 1031 tax deferred exchange by real estate owners. Section 1031 is a time-honored, perfectly legal, tax strategy in which a taxpayer disposes of trade or business or investment real estate and replaces it with qualifying property, while deferring taxation for years or even indefinitely.

During 2012, investors who were selling out of real estate deals took a long, hard look at simply paying the tax. Now that the tax structure has changed dramatically, that is not the case for 2013 and beyond:

  • The top federal individual and capital gains rates have climbed 4.6% and 5%, respectively.
  • The new 3.8% net investment income tax also generally applies to gains from sales of rental or investment properties.
  • The itemized deduction phase out, if applicable, accounts for a 1% tax hike and the personal exemption phase out is a 1% tax hike per exemption over its range.

As a result, many investors will realize a 10-12% tax increase on the gain from sale of a property in 2013 versus 2012.

Section 1031 allows a taxpayer who wants to remain invested in real estate to trade their investment in one project for another without the burden of having to pay tax. The basic axiom is to trade equal or up in value and equal or up in equity to have a fully tax deferred exchange. An investor has 45 days from closing on a relinquished property to identify a replacement property and 180 days from original closing to acquire the replacement. Multiple properties can be exchanged for one replacement property. Multiple replacement properties can be acquired for one relinquished property. Exchanges can be done in forward or reverse order and a replacement property can even be one that is not in existence yet.

Section 1031 is a very form driven code section: there are many “i’s” to dot and “t’s” to cross. At the same time, it provides a very flexible set of rules which allow an investor to move from one real estate investment to another while keeping 100% of the equity deployed rather than 60-80% as in a taxable transaction.

Contact us for assistance in structuring such a transaction.

Kenneth Zacharias, CPA, has a broad background in income tax and general business consulting. He has extensive experience in taxation issues concerning real estate, including like-kind exchanges, use of partnerships and LLCs, construction and developer issues, and capital gains planning. 

Tags: Real Estate