Exchange Services
The fundamental advantages of a tax deferred exchange may be utilized to diversify, consolidate or leverage your investment portfolio. With respect to real property, the broad definition of "like kind" provides investors with numerous options to accomplish their investment goals.
Properties that qualify for IRC Section 1031 treatment
IRC Section 1031 provides that to qualify for tax deferred treatment, the relinquished property must be exchanged for replacement property that is like kind. Like kind means similar in nature and character notwithstanding differences in grade or quality. The fact that any real estate involved is improved or unimproved is not material for that fact relates only to the grade or quality of the property and not its kind or class. As such, raw land held for investment may be exchanged for single-family rentals used for a trade or business or any combination of the following:
- Single Family Rentals
- Farms/Ranches
- Office/Commercial
- Motels/Hotels
- Golf Courses
- Some Recreational Properties
- Multi Family Rentals
- Raw Land
- Retail/Industrial
- Leasehold Interest of 30 years or more
While the definition of like kind is stricter when it comes to personal property – investors may still take advantage of tax deferred treatment in an IRC Section 1031 exchange in the sale of investment personal property. The personal property exchange can be utilized to relocate a business, to upgrade equipment, or to streamline production by replacing outdated technology and machinery with more efficient models.
- Like kind personal property includes:
- Livestock of the same sex
- Automobiles for automobiles
- Buses for buses
- Corporate aircraft for corporate jet
- Doctor practice for doctor practice
- Manufacturing equipment for manufacturing equipment
- Restaurant equipment for restaurant equipment
Benefits Of A 1031 Exchange
Don't sell your income or investment property until you Do the Math
Taxes are paid on capital gain, not equity or profit. It is possible to sell property without realizing much profit and still owe substantial capital gains tax. Capital gain is simply the difference between the sales price and the adjusted basis (i.e., what you paid for the property, plus amounts spent on capital improvements, less depreciation taken) less any closing costs associated with the sale.
To calculate your estimated capital gain – first subtract the adjusted basis from the sales price; then subtract the costs of your transaction, commission, fees, transfer tax, etc.; finally, multiply the capital gain by your combined tax rates (Federal and State) to determine your estimated capital gain tax.
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1. Calculate Net Adjusted Basis: |
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Example |
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Original Purchase Price |
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$400,000 |
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Plus Capital Improvements |
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$25,000 |
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Minus Depreciation Taken |
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($175,000) |
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Equals Adjusted Basis |
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$250,000 |
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2. Calculate Capital Gain: |
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Current Sales Price |
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$600,000 |
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Minus Exchange Expenses |
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($30,000) |
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Minus Adjusted Basis |
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($250,000) |
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Equals Capital Gain |
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$320,000 |
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3. Calculate Capital Gain Tax: |
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Gain Attributable to Depreciation |
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$43,750 |
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Plus Federal Capital Gain Tax |
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$21,750 |
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Plus State Capital Gain Tax |
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$ 32,000 |
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= Combined Tax Due |
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$97,500 |
The formula set forth above is provided to help you determine your approximate gain and the sums that you may wish to defer through your exchange transaction. Consult with your tax advisor to determine the correct values and whether an exchange is appropriate for your circumstances.
100% Deferral
To fully defer state and federal capital gain taxes, the Exchanger must reinvest all exchange proceeds and either acquire property with equal or greater debt or reinvest additional cash equal to the debt relief. The following worksheet is a useful tool for determining the amount of cash and debt that should go into the replacement property.
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Your minimum down payment for the replacement property should be equal to or greater than the net proceeds from the sale of your relinquished property. Otherwise, you may have boot in the form of cash.