The 1031 exchange provision in the new tax overhaul is now expressly limited to real estate exchanges. (1031’s used to apply to “any like-kind exchanges” of personal intangible property such as artwork…not anymore.) The “new” 1031 exchange allows taxpayers to defer capital gains after selling an investment property IF the taxpayer reinvests the proceeds of that sale in another business or investment property.
This tax provision is for every real estate investor, large or small. “You don’t have to be a professional investor to use this tax break to give yourself this advantage,” said Andy Weiser, an agent with Better Homes and Gardens Florida First Real Estate in Fort Lauderdale. “You just have to be smart.”
The 1031 exchange provision only applies to properties that have been held for business or investment purposes. The exchange provision does no† apply to a property used as a personal residence. The taxpayer/seller of the business/investment property has 45 days from the date of the sale to identify a potential replacement property. The taxpayer/now buyer must acquire the new property no later than 180 days after the date of the sale of the formerly owned property.
Many types of real estate qualify for a 1031 exchange. The key is that the property is used for business/investment purposes. For example, a single-family house that was held for investment (as a rental) can be exchanged for a farm or for a building in a strip mall as long as that farm or building is used for business or investment purposes. Successive 1031 exchanges essentially swap each property into a newer or bigger or better property.
When the investor eventually dies, the heirs who inherit the last property will receive a “stepped up basis,” meaning that the value of the last property is determined by the market value of the property at the time of the investor’s death. If/when the heirs sell that last property, there will likely be no capital gains taxes due on the sale of that property.
“Essentially, you just keep buying and selling and rolling the profits from one property to the next,” said David Goss, the founder and managing principal of Interra Realty in Chicago. “When you die and your kids inherit the property, they get a stepped-up basis so the capital gains are gone forever.”
You and/or your clients may want to consider a 1031 exchange for your/their vacation home. Consult with a tax attorney and/or financial advisor first. There is more to a 1031 exchange than just wanting to avoid paying taxes. There is more to it than knowing one can convert that home from your/their own personal use to a business use by renting out the home for at least 14 days/year for two successive years before you/they sell it.
Be a truly savvy real estate investor. Consult with a tax attorney/financial advisor to find out whether or not a 1031 exchange is right for you.