BY: JIM CHRISTMAN, Vice President & Trust Officer
(337) 436-2966 jchristman@argenttrust.com
Even though, thanks to tax reform, U.S. tax rates are today much more competitive on a global basis, our country still has some of the highest capital gains tax in the industrialized world. (For example, we still rank 25th on the International Tax Competitiveness Index. We ranked 30th before tax reform.)
Taxes on real estate investments also remain high. If you’re selling your investment property within a year of purchase, taxes will take as much as 25 percent of your proceeds.
Fortunately, 1031 Exchanges offer a solution to this “taxing” situation – allowing you to defer taxes on the proceeds of a property sale if you invest them in a like-kind replacement. This gives you the flexibility to be more responsive to the highs and lows of the real estate market.
Section 1031 and Tax Reform
Any 1031 Exchanges carried out before the end of 2017 covered many different investment properties, including art and partnership interests. They now apply to narrower categories of like-kind investments in real estate and business. Section 1031 no longer applies to:
- • Stock in trade
- • Certificates of trust
- • Securities
- • Debt
- • Notes, stocks and bonds
- • Partnership interests
Intangibles like franchise licenses and vehicles were also removed from the list, and. tangible business assets like hotel furniture and farm machinery can no longer be deferred. Should the House and Senate experience power shifts due to election results and make further adjustments, Section 1031 might be honed even more.
Investment Real Estate
If your net proceeds from the sale of a real estate property represent a gain on your original investment, you will be taxed on depreciation recapture and a range of other liabilities, which significantly reduces the net equity you’re left with. Depreciation recapture is a gain that is taxed as part of your income, and you’d ordinarily have to pay it at the time of sale. 1031 Exchanges let you defer your gains tax when you replace your investment with a property like the one you sold. This way, you can reinvest your entire gross equity into new property, which would open up your assets to far more growth.
Understanding Like-Kind
A 1031 Exchange can include like-kind property alone – the same type of property you originally owned. The moment you include properties that aren’t like-kind, you might have to pay tax on some of your gain. A like-kind exchange is less inflexible than you might think, though. You needn’t acquire only one replacement property. Two or more like-kind properties would be eligible, for example. That said, merely selling a property and buying another doesn’t qualify you for this deference. Both properties need to be held as investments or for use in a trade. They also need to be a similar type of real estate. A vacant plot can be bought in exchange for a developed rental house, but vacant land is not like-kind to improvements done without land. Domestic real estate, however, cannot be like-kind to foreign property. Argent Financial Group understands the complexity of exchanges and will guide your process in a way that suits your needs uniquely.
Time Limits
Your 1031 Exchange doesn’t have to happen simultaneously. You have 45 days to find a replacement property – and this is rarely extended. Your ultimate exchange must be finalized within six months of your sale.
When Not to Do a 1031 Exchange
Like-kind exchanges don’t cancel your gains tax, only defer it. It doesn’t make sense, then, to reinvest in an ailing property market. If you need to reduce your real estate exposure, a like-kind exchange can prevent you from moving your investment offshore or keep you trapped in a real estate niche that exposes you to too much risk. You should never have to lose principal value simply to qualify for a 1031 Exchange. The consequence of your exchange should be increased capital growth or cash flow. Your portfolio should look shinier once you’re finished, not merely different. If, for example, you’ve invested in the right kind of real estate in the wrong state, but trading up brings prohibited gains tax, an exchange can prepare you for a vastly better financial future.
If you or your advisor misunderstand the minutiae involved in this kind of exchange, and the IRS accuses you of refinancing property in preparation for it, your gain might become fully taxable. Argent Financial Group thus computes the basis of your new property in a way that’s fully compliant with Section 1031 regulations. Only an exchange specialist can offer the excellence we know you deserve, so that’s who will guide you.
We help coordinate 1031 Exchanges, and can work in tandem with your attorney and CPA. As a trust company, we’re held to the most stringent of regulatory standards, so you can feel secure in the knowledge that we will treat your wealth with the deference it deserves.
