According to the National Association of Realtors, median home prices in September 2021 were up 13.3% compared with the same time a year earlier (NAR, Summary of September 2021 Existing Home Sales Statistics). Meanwhile, interest rates on 30-year fixed-rate mortgages have remained flat at an attractive rate of just above 3% on average. Alternatively, property owners might want to capitalize on increased appreciation by reinvesting in other income-producing properties. Tax professionals and trusted advisers should be prepared to educate their clients regarding the potential tax consequences of sale or reinvestment decisions. The discussion below summarizes the changes proposed that would affect deferral of capital gains and depreciation recapture related to exchanges of like-kind real property. As will be seen, investors would experience a significant loss of tax benefit from carrying out such an exchange if the White House proposal is enacted.
From The Tax Adviser
The tax bill will include the original deferred gain plus any new profit you’ve made since. Many people mistakenly think a 1031 exchange makes their tax bill disappear forever. The taxes are deferred, which just means they’re pushed down the road.
- Suppose you decide to sell an office building you purchased three years ago.
- This distinction is critical for investors optimizing tax deferral strategies while ensuring compliance.
- For those interested in the legal history, the American Bar Association offers some great background information.
- The first step in a 1031 exchange is determining the original basis, which includes the purchase price of the relinquished property and acquisition costs like legal fees and title insurance.
- For example, exchanging a commercial property with a 39-year depreciation schedule for a residential property depreciated over 27.5 years requires adjustments to financial planning.
- Explore property-related timing issues and planning opportunities that can lead to significant tax savings.
Defer the tax. MAXIMIZE your gain.
The 45-day identification period requires taxpayers to formally designate potential replacement properties in writing, while the 180-day rule dictates when the exchange must be finalized. Missing these deadlines results in disqualification, making any realized gain immediately taxable. Documentation should reflect adherence to these timeframes to support the exchange’s validity in case of IRS review.
Microcaptive insurance arrangements subject to new rules
Ensure your identification notice is in writing, unambiguous, and sent to your QI before the deadline. When you’re accounting for the sale and purchase price of your real property, you can use accounting tools to generate accurate transaction reports that cover the relevant details of the exchange. These tools also make 1031 exchange accounting entries tax reporting for real estate investments easy. Secondly, it may be difficult to identify replacement properties within the specified timeframe.
- It opens up a world of strategic possibilities, allowing you to pivot your investment strategy without triggering a taxable event.
- But, what if John made an error while calculating the adjusted basis of the sold property?
- Every transaction is recorded in one of those five areas , including everything from rent payments to maintenance costs.
To legally defer capital gains taxes, you must complete the improvement within 180 days after the day you sell your relinquished property. Sec. 1031 also provides for the deferral of depreciation recapture, currently taxed at a flat rate of 25% upon sale of an investment property. Deferral of taxation in a reinvestment situation is in keeping with a long-held sentiment that taxes should be collected when taxpayers have the wherewithal to pay. If the proceeds from the sale of an investment property are being reinvested, the taxpayer may not have the wherewithal to pay income taxes.
How To Record A 1031 Exchange
Furthermore, keep records of other exchange-related expenses, such as closing costs, intermediary fees, etc. To report your like-kind exchange, use Form 8824 and attach it to your tax return in the same tax year as the exchange. To avoid facing challenges, hire a Certified Public Accountant (CPA) or tax adviser. They understand tax implications and can structure your exchange to ensure compliance with tax rules. Also, a tax accountant and CPAs accurately document your tax returns and financial statements in a 1031 exchange.
The 180-Day Exchange Period
The reduced basis adds to the potential capital gains tax when the asset is sold. If you are thinking of selling your investment property, make sure to reach out to your CPA or Financial Advisor to discuss your options. Like its name, the 1031 exchange is gotten from Section 1031 of the U.S. President Joe Biden has proposed numerous changes to the tax code that would significantly affect investors who are making the sale/reinvestment decision. As of this writing, Congress is considering major tax reform, and one of the many proposed changes is a limitation on the amount of gain that may be deferred in a reinvestment situation. Specifically, Biden has proposed limiting capital gain deferral in a like-kind exchange to a maximum of $500,000 ($1 million for married individuals filing a joint return).
Hence, you may encounter certain challenges while accounting for 1031 exchanges. In this blog, you’ll learn how to account for 1031 exchanges in California and the various tools that can make the process easy and efficient. The chart “Total Tax Liability From Sale of Relinquished Property Under Proposed Rules” shows the tax consequences under the proposed changes if A sells the property outright.
A Time-Tested Tool with Very Strict Rules
The Tax Cuts and Jobs Act made some changes to the Section 1031 exchange rules. Personal property and intangible property will no longer qualify for a like-kind exchange. Moreover, you can’t use real properties held for sale for a like-kind exchange only investment properties. It applies when you swap two real estate properties with the same nature or character. Even if the quality or grade of these properties differs, they may still qualify for like-kind exchange treatment.
