Having a tax attorney you trust can help you save money on taxes, business deals and other business expenses. Many new business owners or investors don’t know about or fully understand 1031 exchanges, meaning they miss out on significant savings.
At KJK, our tax attorney practice group has extensive experience with all types of tax problems and solutions, from helping nonprofits apply for tax-exempt status to showing investors how to save money with a 1031 exchange.
Important to Know:
What is a 1031 Exchange?
A 1031 exchange takes its name from a section of the IRS code, 1031. If you exchange a “like-kind” property with another investor, you won’t need to pay capital gains tax on the exchange.
You can either perform a simultaneous exchange, where you and another investor swap properties, or a deferred exchange, where you sell your property and then invest that money within 180 days. You can also opt for a reverse exchange, which involves an exchange accommodation titleholder, and is the most complex of the options.
After selling your property, you have 45 days to identify like-kind replacement properties and 180 days to complete the replacement process.
A qualified intermediary holds the proceeds from the sale, transferring them to the identified like-kind property owner. This means you never hold the proceeds, exempting you from capital gains tax.
A 1031 tax exchange can save you significant amounts of money. However, you must follow all the 1031 exchange rules exactly; otherwise, you may end up owing the IRS money.
President Biden has proposed eliminating the 1031 exchange program as part of his policy proposal, “The Biden Plan for Mobilizing American Talent and Heart to Create a 21st Century Caregiving and Education Workforce.” Our tax attorneys are monitoring any developments regarding the potential repeal of 1031 exchanges.
Valuable information to Consider
Who Should Consider 1031 Exchanges?
Real estate investors who want to move into a new area or sell a current property should consider a 1031 exchange instead of an outright sale. The IRS views an outright sale as cashing out, which means it requires you to pay capital gains tax. On investment properties, this tax is often significant and cuts down on your profits.
However, to qualify for a 1031 exchange, you must exchange properties of equal or greater value.
People may consider a 1031 exchange if they want to invest in a managed property rather than managing it themselves, or they want to either divide or consolidate their property as a tactic for estate planning. Alternatively, they may want to turn back the depreciation clock or want a property that could provide more return for the money later on.
What Types of Property Qualifies for a 1031 Exchange?
Generally, only commercial property qualifies for a 1031 exchange. While you must exchange like-kind properties, the term like-kind is much broader than many think. Rather than referring to the type of property like a farm or a high-rise, it refers to the property’s intended use.
To qualify, you must intend to use the property as a long-term investment or in your business. This could mean having rental apartments in a high-rise or developing a housing community.
However, the following types of property do not qualify for a 1031 exchange:
- Your primary residence
- Property you intend to flip quickly for profit
- Property owned by a relative
- International property
- Notes, bonds or stocks
- Debt or securities
- Partnership interests
- Certificates of trust
Do I Need an Attorney for a 1031 Exchange?
While you can perform a 1031 exchange without an attorney, having our experienced team on your side can ensure you follow the rules and receive the maximum benefits from the exchange. Failure to meet the deadlines or choose an appropriate property can result in high capital gains taxes.
The team at KJK can help you identify property and help you find a qualified intermediary.
Finding a Qualified Intermediary
Because you must pay taxes on any profit made from a sale, a 1031 exchange requires a Qualified Intermediary who receives the proceeds from your property sale and then, once you’ve identified a property, transfers them to that property owner.
Neither the buyer nor the seller can have a formal relationship with the qualified intermediary; however, they must create an agreement with both before the transaction. This means that your current attorney, a relative or someone you’ve had recent financial dealings with cannot act as your Qualified Intermediary.
While you can hire anyone who fits the requirements to act as your Qualified Intermediary, it is better to work with someone who has extensive experience with 1031 exchanges. KJK can recommend someone to you, or you can find someone through the Federation of Exchange Accommodators.
How KJK Can Help You Avoid Common Pitfalls of 1031 Exchanges
Making a 1031 exchange isn’t easy, and KJK can help you avoid these common mistakes:
- Missing deadlines: The deadlines depend on the type of 1031 exchange you complete. We can ensure you understand the rules for your chosen type of exchange and complete the exchange in time.
- Working with relatives: Many investors wish to swap properties with relatives, hoping to keep the property in the family. However, this goes against the regulations. Our team helps you identify property owners you can legally work with.
- Using the wrong person as a Qualified Intermediary: If you don’t choose your Qualified Intermediary wisely, your entire exchange could be invalidated. KJK can ensure you choose the correct person by either recommending someone or vetting the person you choose.
- Waiting to engage in a 1031 after closing: Unfortunately, you must have already chosen a Qualified Intermediary before your sale closes. Otherwise, it’s too late. If you’re considering a 1031 exchange, consult with the KJK team before selling your property.
1031 Exchange Do’s and Don’ts
Having a quick checklist of do’s and don’ts can help ensure you have a successful 1031 exchange.
- Do plan in advance. Speak with your attorney at KJK, your financial planner, your lender and your preferred Qualified Intermediary before taking any steps.
- Do ensure you exchange your property for like-kind property of equal or greater value to benefit from full tax deferment.
- Don’t ask a relative or your attorney to act as your Qualified Intermediary.
- Don’t alter the title or relevant partnerships during the 1031 exchange since this could affect its success.
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A 1031 exchange can help you save money while also acquiring new property. Call KJK today to learn how we can help your business save money while expanding.