1031 Exchange Calculator
This calculator will help you to determine the tax deferment realized by performing a 1031 tax exchange rather than a taxable sale. Click on the second tab to calculate the 45 & 180 day property exchange deadlines.
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Like-kind Exchange Deadline Calculator
Quickly calculate the 45 & 180 day deadlines on your 1031 tax exchange.
45 Day Deadline: Must identify potential like-kind replacement properties to the qualified intermediary no later than midnight of the 45th calendar day following the close of the relinquished property sale transaction.
180 Day Deadline: Must complete the 1031 exchange transaction, which includes the conveyance of title to all of your like-kind replacement properties that you intend to acquire, no later than the earlier of:
- midnight of the 180th calendar day following the close of the relinquished property sale transaction, or
- the due date of your Federal income tax return for the tax year in which the relinquished property was sold, including any extensions of time to file.
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Managing Your Taxable Returns Through 1031 Exchanges
Nobody appreciates excessive taxation. Investors in particular can lose a lot of their gains through taxation each time they cash out. Fortunately, you can take advantage of several provisions to reduce your tax burdens. One of the best ways to save on taxation is through the 1031 exchange. This method lets investors delay taxation through reinvestment.
The exchange gets its name from the section of the tax code that allows it. It is also known as the like-kind or tax-deferred exchange. Through it, you can reinvest your money without incurring taxes. Although not without its difficulties, the 1031 exchange is well worth the effort.
The Tax Burden of Capital Gains
Capital gains taxes cut into the profits you earn from any investment. In the U.S., the losses incurred by capital gains are even greater when you don’t invest in the long run. Traders find that buying and selling stocks has a higher tax burden than holding onto them. These and other assets held for less than a year fall under short-term capital gains taxes.
Investors can save on taxes by holding onto their assets for at least a year or longer. These will be subject to long-term capital gains taxes, which are much lower. However, no matter how long you invest in real estate, your capital gains taxes will always be hefty. That’s because real estate grows in value. This is where 1031 exchanges come in.
A section 1031 exchange delays taxation when you reinvest. As far as the law is concerned, you reinvested the same money in a different investment. Through this, you can defer a majority of your taxes until the next time you sell. In practice, this can be far off into the future since you can reinvest again. There is no limit to how many times you can reinvest through these exchanges. This way, you can keep deferring much of your taxes almost indefinitely; you will only pay taxes once!
The Fundamentals of a 1031 Exchange
On paper, a 1031 exchange involves trading one like-kind property for another. In some cases, it can be a literal swap. In practice, these are quite rare. It is difficult to find another willing property owner with properties at the right price.
Thus, most 1031 exchanges are deferred exchanges. These involve buying new property with the proceeds of the old one. You must do this within 180 business days after selling the previous property. You can spend at most 45 days of this time searching for like-kind property. The sale must close before the end of the period for the exchange to be valid. If not, then you remain liable for the taxes due on your property.
To defer all your taxes, the new property must be at the same price or greater than your original property. This price must not exceed 200 percent of the selling price of your original property. You can exchange a property worth less than your original. The difference between the two prices, the boot, is taxable. You need only to cover the taxes on this amount; the rest is deferred.
Most 1031 exchanges demand you sell a property and buy a replacement. But it can also work the other way round. In a reverse exchange, you buy a new property before you sell an older one.
Direct swaps as outlined in section 1031 are often difficult to carry out. Many exchanging parties rarely have something that the other wants, or at the right price. Fortunately, the section allows you to carry out swaps through a qualified intermediary (QI). Through a QI, you remove the need to find someone who has the exact property you need.
The QI’s main role is to hold on to your money until the exchange can take place. They must sell your property and keep your sales proceeds until they find a property to exchange. They must then buy you a new one on your behalf. In effect, they conduct much of the legwork of the exchange for you.
While this seems simple enough, it can be quite risky. You and your tax adviser must find a QI you can trust to hold your money for what could be a long time. Complicating matters is that the QI must be independent of you when conducting the transaction to ensure you have no access to your funds. There are two basic guidelines to assigning a QI, according to Treasury Regulations section 1.1031(k)-1(g)(4):
- A QI could be any person who isn’t the exchanger
- A QI must not be a disqualified person. This includes people related to the exchanger or has acted as their agent over the past two years.
In short, anyone who has worked for you in the past two years before the exchange cannot be your QI.
In the past, you could have used other assets in 1031 exchanges, as long as they were for “business purposes.” These encompassed everything from equipment to art. Understandably, this system was open to all kinds of abuse. Thus, since 2018, you can only perform a 1031 exchange on like-kind properties. The term today refers only to business-purpose real estate bought within the United States. These properties, meanwhile, do not fall under these conditions:
- Non-real estate business assets
- U.S. residential real estate that serves as a primary residence
- Any real estate outside the United States
All business-purpose U.S. real estate is like-kind during a 1031 exchange. This includes raw land, rental residences, and commercial and industrial areas. As long as the property is used for a business, it is valid for that use. You can thus use 1031 exchanges to move investments from one property type to another.
Like-kind also does not need to have the same level of improvement. You can exchange an occupied commercial plaza with raw land if they are within the same price range. Indeed, you may even exchange properties that are not in the same state. You can swap a well-maintained rental apartment for a run-down strip mall if the price is right. However, switching from improved to unimproved property may have tax consequences.
Former Homes and Vacation Homes
In special circumstances, it is possible to sell your former house in a 1031 exchange. The condition is if you converted it into a rental property some time before the sale. There are strict rules to ensure this, however. To count, it must have been occupied by a tenant for at least 24 months before sale.
Vacation homes are a more complex matter. You can use them for a specified time each year if you rent it out successfully for the rest of the year. This time span is usually less than 14 days. You may also use your home for at least 10 percent of the time you’ve rented it out. For instance, if you’ve rented your home for 150 days, you may use it for 15 days!
How Much You Can Save
Let’s see the exchange in action. Suppose you have a property you bought for $1,500,000. Over time, you’ve made $145,000 worth of capital improvements and wrote off $95,000 worth of depreciation.
You then sell it for $2,000,000 and spend an extra $100,000 on closing costs. At the time of sale, your remaining mortgage balance was $250,000. Let’s suppose you fall under the 20 percent Federal long-term capital gains tax bracket. Your state’s capital gains tax, meanwhile, hovers around 8 percent.
Thus, here’s where you stand if you sold your property as is:
|Depreciation recapture (25%)||$23,750.00|
Here’s the amount of taxes you managed to defer through the exchange:
|Federal Capital Gains Tax||$67,000.00|
|State Capital Gains Tax||$34,400.00|
In due time, you will have also qualified for a larger loan amount. You can use this to finance larger acquisitions. Based on the tax savings you made, here’s how much more you can afford to reinvest:
|Sale reinvestment (after-tax equity x 4)||$6,419,400.00|
|Sale reinvestment (gross equity x 4)||$6,920,000.00|
The 1031 Advantage
Deferring your taxes through reinvestment works the best for commercial real estate investors. Often, you were going to reinvest that money elsewhere anyway. Through this, you avoid paying taxes more than once through constant reinvestment. As long as you can find a suitable property to exchange, you can delay taxation.
These savings can add up over time. Because you only need to pay taxes once you cash out, you can reinvest several times without paying taxes. For long-term real estate investors, the 1031 exchange is an indispensable part of their tax management strategy.
A 1031 exchange is also an excellent way to reduce the taxation costs of redeploying your assets. You might find the property you have right now to be risky or too much trouble to manage. You only need to exchange the property for another one more to your liking.
Finally, the exchange makes time your ally. Tax laws and tax status are not immutable. In the future, your tax situation may be far more preferable than what you have today. Delaying taxation in effect lowers your taxable costs where it won’t hurt the pocket as much.
Till Death Do Us Part
If you do not need to liquidate your holdings at all, you may use 1031 exchanges to avoid taxes altogether! When your heirs inherit your property, they receive it on a stepped-up basis. This amount is equal to the fair market value of the property at the time of your death. In essence, your heirs eliminated any capital gains taxes from your property.
You could use this to your advantage by reinvesting your money in more expensive properties. In effect, you built a lot of tax-efficient wealth for your heirs.
Avoiding Depreciation Recapture
All physical properties are subject to wear and tear and depreciate in value. Buildings are no exception. In ordinary circumstances, depreciation is your financial ally. As your building loses value through wear, you claim this loss as a tax exemption. But while your building loses value, the land it’s on may not.
Thus, when you sell the property, you risk triggering depreciation recapture. This is when you sell the property for a value higher than its depreciated value. Depreciation recapture charges you a flat rate of 25 percent. This can lead to immense tax consequences if you owned the property for a long time.
A 1031 exchange could be used to avoid the steep costs of recapture. You get a new property through the exchange that has not depreciated as much. If you sell this property, your depreciation capture costs will not be as high. Do remember that these rules apply only to improved properties, i.e. those that have had buildings on them. If you sell a building and buy unimproved land, you may still face depreciation recapture.
The Drawbacks of a 1031 Exchange
Whenever you conduct a successful exchange, your money remains illiquid. Although you did not pay any taxes on reinvestment, you don’t get any cash from the sale. You might even pay a higher amount to avoid taxable boot on selling your property.
Conducting a 1031 exchange comes with strict rules and regulations to follow. You must obey a strict 180 business day time table from the moment you sell to ease the exchange. Full compliance can lead to no income realized from selling your property. Yet, deviate from those regulations enough, and you face stiff tax penalties.
Tax deferrals put off your obligations for another, more convenient day. They do not remove your tax liabilities if you cash out in your lifetime. While there is no limit to how many times you can conduct the exchanges, you can’t do this forever. Once you decide to cash out, the taxes on your investments will be due. If you ever plan to cash out, you must have a strategy in place to reduce the impact of your taxes.
Rental Property Considerations
One complicating factor in a 1031 exchange is when you own rental property. Changing rules meant that you can’t just declare a former residence a rental. You must rent it out. It must also be occupied by a tenant for two years before it becomes eligible for a deferred exchange.
Things get complicated if you live in your own unit in a multifamily rental property. Thus, you must combine the 1031 exchange with a Section 121 exclusion. You can avail of this exclusion if you have lived in that property for at least two years in the last five-year period. This exclusion may only be used every two years.
Selecting a Property
To succeed in a 1031 exchange, you must find the appropriate property to sell within the time limit. This is often the hardest part of the exchange. Seldom will you find the perfect property for your purposes. Keep it within a specific price parameter to maximize your savings. The best like-kind properties for the job are those that meet the following criteria:
- They must cost less than 200 percent of your property’s value, if they are more expensive.
- They must cost at least 95 percent of your property’s sale value.
The likelihood of finding a property worth the exact value of your own is slim. While you will still pay something up front, both reduce the amount of boot created during the sale. While more expensive, choosing pricier property will remove taxable boot altogether. Getting as close as possible, meanwhile, reduces the boot and thus your tax burdens. Which one is less expensive will depend on your situation.
You may also need a specific type of property to reinvest in. This is important if you are avoiding the risks of a specific type of real property.
There are three ways to create your short list of properties for exchange. The first is the three property rule. It involves selecting three properties regardless of their market value. This way, you aren’t spoiled for choice. The 200 percent rule demands you find properties that do not exceed 200 percent of your property’s value. This is the easier of the two choices, but is also more expensive.
The 95 percent rule lets you choose properties as close to your property’s market value. This will reduce the taxable boot by at least 5 percent. While cheaper, this takes a lot more time to do. You will also still pay taxes on the part that wasn’t deferred at all.
Build to Suit
If you’re lucky, you might find a property still being built or improved on. You thus have the option of buying this property in anticipation. A build-to-suit exchange is an agreement with you and the property’s current owner to make improvements that will bolster the property’s value. You should end up with a property that matches your price.
Be aware that the time limit for the exchange still applies. You and your seller must finish all improvements by the 180-day mark. The 95 percent rule lets you choose properties as close to your property’s market value. This will reduce the taxable boot by at least 5 percent. While cheaper, this takes a lot more time to do. You will also still pay taxes on the part that wasn’t deferred at all.
For all the benefits the 1031 exchange offers investors, it is still an intricate process. The Internal Revenue Service (IRS) applies strict guidelines on proper exchanges. Compliance is key to making the most of these exchanges.
A 1031 exchange is a race against time. You must remain compliant while doing everything within the time limit. If the confusing rules aren’t enough, you must also contend with market forces. In a hot market, it could be next to impossible to find the right property before the deadline. If you don’t follow through, you will still owe capital gains taxes plus penalties.
Deferred exchanges are often too complex for you to attempt by yourself. But the rewards you stand to gain could outweigh your risks. Thus, it is vital that you maximize your chances of completing the transaction. Always have a trustworthy professional to guide you through the process.
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