When you want to exchange the equity in your San Diego investment real estate for equity in a property with even greater income potential, a 1031 Exchange will give you more equity to work with. You won’t be subject to capital gains tax on the profit – or on the depreciation you may have taken since acquiring your present property. Funds that would go to taxes in an ordinary sale can instead be rolled into your new investment property.
But you do have to follow strict rules, and one of those rules is that you as the seller may never come in possession of the proceeds of your sale.
A Qualified Intermediary must be appointed to hold the 1031 exchange proceeds, create the exchange, and prepare the legal documents.
This intermediary must be an uninvolved third party and may not be a relative or agent of the exchanging party, except that a real estate agent may serve as the intermediary if the current transaction is the only instance in which the agent has represented the exchanging party in the past two years.
Next are the timing restrictions.
Under the 1984 rule changes, the exchange may be delayed, but with time restrictions.
Once your original San Diego investment property is sold, you have 45 days from the closing date to either close on or identify a potential replacement property or properties. Such identification must be in writing.
This time restriction is not negotiable, and the 45 days includes both holidays and weekends. If you wait until day 46, capital gains tax on your sale is sure to follow.
To complicate matters, you have some options in identification.
- You can, of course, identify only one property.
- You can use the 200% rule. Under this rule you may identify any number of properties as long as the aggregate value of the properties doesn’t exceed 200% of the value of the relinquished property.
- You can use the 95% exemption. In this case you may identify any number of properties as possible replacements, but you must purchase at least 95% of the aggregate value of all the properties identified.
Of course, the 45 day “identification” period doesn’t prevent you and your San Diego real estate agent from doing your homework ahead of time. You can certainly pre-identify and inspect both the properties and the financials so you’re ready to act when the sale of your original property closes.
Closing on the replacement property
You have only 180 days from the closing date on your relinquished property in which to close on the purchase of the replacement property. Again, the restriction is not negotiable. 181 days won’t do.
And… if the due date for your income taxes falls within that 180 day time frame, that due date becomes your end date. Thus, it’s probably unwise to sell under a 1031 exchange after November 15 if your taxes will be due on April 15.
To effect complete tax deferment, the following three restrictions must be met.
1. The properties involved must be “like kind.”
2. The total purchase price of the replacement property must be equal to or greater than the total net sales price of the relinquished property.
3. All of the equity from the sale of the relinquished property must be used to acquire the replacement property.
The “like kind” rule is absolute. You may engage in a transfer that results in cash profit from the relinquished property, but in that case, tax will be due on any non-like kind profit – also referred to as “boot.”
What is “boot?”
“Boot” is the money or fair market value of any additional property received by the taxpayer through the exchange.
“Money” is taken to mean all cash equivalents, debts, and /or liabilities to which the exchanged property is subject. Determining the relative liabilities and their effect on your transaction is a job for a knowledgeable San Diego CPA, working in conjunction with your tax advisor.
“Additional property” could be taken to mean any property which is not “like kind.” For instance, a personal residence or vacation property not used in the taxpayer’s trade or business and not held for investment.
To learn more, just call…
If you think a 1031 Exchange might be right for you, call 619-929-1413 and talk to one of our San Diego real estate investment specialists. We’ll be happy to give you more information and help you determine the value of your current holdings.
Note* The 1031 Exchange information on this site is meant as an overview and is not to be taken as tax advice. To determine how a 1031 Exchange would affect you, please consult your tax advisor and/or your tax attorney.