Do you own a current investment or business property? Are you considering a 1031 exchange (also called a Starker Exchange) to defer the capital gains tax?
If so, plan ahead!
The 1031 Exchange Benefits
By using a 1031 exchange investors are able to defer the capital gains tax on a property by exchanging their current property for another property. Both properties must be held for investment or business purposes, they cannot be intended for personal use.
The use of an exchange allows an investor to accumulate more assets before paying taxes on previous gains.
Changes in 1031 Exchanges
1031 exchanges have been around for a long time. Many seasoned real estate investors have used them to defer capital gains taxes on their properties, thus accumulating larger assets. Recently, the IRS is under pressure to generate more revenue and is paying closer attention to all tax issues. 1031 exchanges are no exception to the IRS’ scrutiny.
The 1065 form that is reported to the IRS requests information that wasn’t previously tracked. This information can be a means of triggering an IRS audit. The “Drop and Swap” model of 1031 partnership dissolution is under close scrutiny and may require you to dissolve the entity a year prior to the close of escrow.
If you are considering a 1031 Exchange, plan ahead. Depending on your advisors’ counsel, you may need to plan as early as one year prior to the close of escrow.
- Meet with your CPA or tax professional when even considering a potential sale. Your tax professional can help you plan ahead to avoid a disqualification of your exchange and undue scrutiny by the IRS.
- Meet with your estate planner to make sure you end up holding title in the correct entity after acquisition.
- Meet with your exchange accomodator to have them walk you through the timing and procedures that need to be followed.
- Meet with your real estate professional. Let them know what you are planning to do and when you are planning to do it. Let them give you suggestions for maximizing the value of your current property. Let them help you begin to identify a replacement property prior to selling your existing property.
The guidelines and time frames for 1031 exchanges are very tight and inflexible and don’t allow for a change of heart after the fact. Planning ahead in a 1031 exchange can help you avoid mistakes that will force you to pay taxes and incur costly interest and penalties due to hasty, forced decisions.