If you’re a real estate investor, you might be interested in learning about what a 1031 Exchange is and how it can benefit you when buying and selling. Lucky for you, I’ve got the 1031 guru, Mr. Tom Gustafson with Atlas 1031, Exchange.
This is Tom.
Here’s what you need to know about Tom:
1. He loves Nicholas Cage.
2. He’s who you call (after me) if you want to avoid taxes when selling an investment property.
After Tom and I discussed his new branding strategy with his headshot, we dove into breaking down what a 1031 Exchange is for folks who might not understand it.
AM: Can you explain in laymen’s terms what a 1031 Exchange is?
Tom: A 1031 Exchange allows real estate investors and business owners to defer up to 100% of the capital gains taxes and recaptured depreciation that would come due upon the sale of the property they held for trade, business or investment, if reinvested and held in a like kind property.
AM: Who can do a 1031 Exchange?
Tom: Any individual that has an Individual Tax Identification Number. This could be an ITIN, SS# or EIN in the case of a business entity. This is important because even foreign investors can participate in 1031 exchange treatment as long as they have an ITIN. Most commonly, we see individual investors who are selling single family investment homes and replacing with new single family investment homes.
AM: Let’s say I have an investment property that I want to sell. I have about $100K in profit, if I don’t do a 1031 Exchange, how does the IRS handle the profit I make?
Tom: You would be subject to Federal Capital Gains Taxes if you’ve held the property for more than one year and one day. In Florida, there is no State Capital Gains Tax however in many states it’s substantial. Additionally, the IRS will recapture depreciation on the property sold to the tune of 25%. Everyone’s tax architecture is different and has to do with income levels amongst other things, a CPA would be a terrific resource to calculate your exact amount that would be due or deferred through a 1031 exchange.
AM: That was explained so well. Your vocabulary is very vast, Tom. Next question, let’s say I don’t want to be taxed on the profit, would I need to use the entire $100K to put into a new investment?
Tom: You would not! You could take “boot” which would be a portion of your net sales proceeds that you could take and pay taxes and recaptured depreciation on. This happens often. It’s also referred to as a “Partial Exchange”, and there is a common misconception that you can’t do them, but you can!
AM: How long would I have to find a new property?
Tom: The Exchanger would have 45 calendar days from the day of closing on their relinquished property (the property they sell to initiate the 1031 exchange).
AM: What would happen if I missed the deadline to find a new property, is there any other safe harbor for the profit I made?Tom: There is not, the calendar day limitations are inflexible.
AM: Could I take the $100K in profit and use it in multiple investments and is there a limit on how many investments that profit can be used for?
Tom: You can! There are specific identification rules that allow you to identify up to three properties regardless of value, or over four properties as long as the aggregate value of those properties does not exceed 200% of the sales price of the relinquished property. You could use either of these rules to determine how many properties you re-invest into.
AM: If my previous investment was a single family home, could I re-invest in land, commercial property, etc? Is there any limitation on where my funds can be invested into next?
Tom: This is also one of the most common misconceptions around 1031 exchanges. “Like Kind” is a very general term that is used meaning you have to replace your property with “Like Kind” property. You are able to replace the property with almost any type of real property (real estate) as long it is held and used for investment, business or trade purposes. You could sell a condo and buy a warehouse. You could sell an apartment complex and buy timberland. You could sell a quadplex and buy an interest in a Delaware Statutory Trust. There are many options.
AM: Let’s say I’ve found my replacement property, it’s an awesome beach condo, and my 1031 Exchange is done successfully. My end goal is to make my beach condo my primary residence, is there a way that can be accomplished?
Tom: This can be accomplished but you would need to rent the property out at fair market value rent for two years before considering the transition. The intent at the purchase of the property should be for investment purposes and two years satisfies the IRS requirement.
AM: So you’re telling me I could buy a single family house near a college or university, rent it out for a few years. Take that profit out to the beach, and rent that property for X number of years, and then roll into making the beach condo my primary residence and I’ve avoided being taxed on my investment profits?
Tom: Bingo! Yes.
If you can’t tell, Tom knows A LOT about 1031 Exchanges and is very easy and fun to talk with. If you need to sell investment property and re-invest to avoid paying taxes, Tom and I can help you from start to finish.
We leave you with some Nicholas Cage, because who doesn’t love a little SNL weekend update with Nick Cage x 2.