Thinking of swapping your ski lodge in Aspen for an oceanfront mansion in Miami Beach? If you have used your holiday home as an investment property and received rental income, you may be able to take advantage of popular tax relief which allows you to defer payment of any capital gains tax due to sale or perhaps avoid them. entirely.
Like-kind exchanges, also known as 1031 exchanges for the section of the IRS they fall under, allow taxpayers to exchange real estate used for business or investment purposes for like-kind property. without paying taxes on the product. Instead, these gains are deferred until the taxpayer finally cashes in by selling the property. Under the tax code, any type of real estate used for business or investment purposes is considered a type, so vacant farmland can be replaced with industrial property in a 1031 exchange. IRS rules, a home used solely for personal purposes, whether as a primary residence or a vacation home, would not qualify for similar exchange treatment.
Although like-for-like swaps are a popular tax strategy for large institutional investors buying and selling commercial real estate such as office buildings, individual investors often benefit from the break as well, whether they own small buildings apartments, single-family rentals or vacation rentals. dwellings used for professional purposes. In fact, according to data firm CoStar Group, the share of deals worth $1 million or less grew from 18% in 2017 to 32% in 2021.
Miltiadis Kastanis, senior director of luxury sales for Douglas Elliman Real Estate in Miami, said more of his clients are looking for 1031 exchanges now than in previous years due to soaring real estate prices. “Markets across the country are so robust that people are taking advantage of the high value of their properties and applying those gains to properties in other markets,” he said. “The ability to defer capital gains is the primary driver of a 1031 exchange.”
Mr Kastanis said he is currently working with a Rhode Island buyer who is considering selling a vacation home in the Hamptons and swapping it for one in Miami Beach. The buyer plans to use the new home as a rental property and, subject to IRS rules limiting the amount of time he can personally use the home, also for personal purposes.
To be successful in a 1031 exchange, investors must meet strict deadlines. First, the taxpayer must identify one or more replacement properties within 45 days of the date of the sale. Then, the replacement property must be acquired within 180 days of the sale. If you miss these deadlines, you will lose the tax benefits of Section 1031.
But finding and closing a replacement property on time can be a challenge in today’s market, where inventory is, in many markets, at historic lows. Mr. Kastanis said he often looks for off-market opportunities due to the scarcity of stocks in Miami.
Yet savvy investors are closing deals and deferring taxes, in some cases for decades. Louis Appignani, 88, a retired entrepreneur from Miami, bought his first office building in 1993 for $2.5 million. He sold it in 2015 for $14.5 million, a gain of $12 million, but paid no taxes because he acquired an 80-acre working ranch in Jackson Hole, Wyo for 14, $5 million in a 1031 exchange. Mr. Appignani planned to keep this land, but he received an unsolicited offer for it in 2020 and eventually sold the land for $25 million. He used that money in another 1031 exchange to purchase five parcels of land in Asheville, North Carolina.
“My $2.5 million investment was converted to $25 million and I paid no tax on it,” he said. “Rather than pay the government, I delayed it and reinvested it.”
Under the current tax code, taxpayers who make successive 1031 exchanges without paying capital gains tax and then die can avoid tax altogether since their heirs will inherit that property with a gross-up base equal to the value of the property at the time of death. . This makes 1031 exchanges a great estate planning tool.
Here are some things to consider if you’re considering a similar exchange.
Be aware that the rules may change. The U.S. Plan for Families proposed by President Biden calls for limiting the deferral of capital gains in a 1031 exchange to a maximum of $500,000 for single taxpayers or $1 million for married couples filing jointly. While these provisions are pending and subject to change, please be aware that 1031 exchanges may be limited in the future.
Use a qualified intermediary. To avoid triggering a taxable event, always use a so-called qualified intermediary, such as a lawyer, accountant or title company, to facilitate a 1031 exchange. This intermediary will keep the proceeds from the sale of the abandoned property and the will use to acquire the replacement property, thus avoiding the taxpayer having to come into contact with the proceeds of the transaction, which is prohibited. Marilyn Wright, a broker at Premier Sotheby’s International Realty in Asheville, North Carolina, always asks her clients to use a qualified intermediary when making a 1031 exchange. “Making sure it’s done correctly is imperative,” she said. “Most real estate agents aren’t good at handling the paperwork involved, and I know I don’t want to be responsible for messing up the deal. Even the agents I know who regularly do 1031 exchanges have a company that does it for them.
Dare on Delaware Statutory Trusts. To avoid difficulty meeting the strict deadlines required by the Internal Revenue Code, Steve Moskowitz, a tax attorney in San Francisco, recommends naming a Delaware Statutory Trust, a separate legal entity similar to a real estate investment trust, like the one of the replacement properties. This way, since the IRS ruled in 2004 that certain DST stocks are treated as replacement property in a 1031 exchange, if the seller cannot find or close a suitable replacement property in time, they can proceed to purchase of DST shares to complete the exchange. “Because of the strict time guidelines, a lot of people fall into a trap,” he said. “They think they’re going to do a 1031 but they miss the deadline and get stuck paying taxes.” By naming a DST as a replacement property, however, taxpayers can avoid this risk.