Last updated on September 29th, 2023 at 08:09 pm
Here’s what to do 12 months in advance of your 1031 exchange:
1. Start planning.
What does it mean to start planning? You have to think about your goals.
2. Understand the process.
Let’s go over the 1031 exchange process.
a. Show your intent.
You’re going to show your intent from the very beginning because intent is really important to the IRS.
What does that mean? It means that you are showing the property has been a rental or a property held for several years as an investment, a part of your business, and your intent is to exchange it. On the documents that you sign with your real estate broker, it will say it is the seller’s intent to participate in an IRS 1031 exchange.
b. Sell your rental.
c. All funds from your sale will go directly into the funds of a Qualified Intermediary. All the funds from your sale will go directly to a Qualified Intermediary.
d. Designate your “buy properties” within 45 days in writing to your Qualified Intermediary.
After the process of being in your contract to buy the new property or properties, you will then…
f. Authorize the qualified intermediary to forward the funds to close the escrow. This has to close within 180 days of the closing of your original sale.
So, we’re 12 months in advance of your 1031 exchange and you are close to understanding the process.
You remember that you have to buy in the same entity, meaning that if you are a husband and wife, the purchase is going to be in the name of your husband and wife. If you’re a single person, it’s going to be in your name. If you’re a corporation, you’re buying in the corporation or the trust or whatever entity you are using.
The other part of the process that you want to remember is that you have to actually buy a property that’s equal or greater in equity and loans.
3. Evaluate your current position.
What does that mean? It means understand the taxes you might pay, understand your property, in the sense of what do you need to do on the property to get it ready for sale?
Do you need to raise the rents? Do you need to perhaps fix up the property, make it in better condition, do some correction of deferred maintenance? What do you need to do to the property? And what do you need to do in your own situation? Also, what about your financial situation? Do you need to get a loan? Do you need to work on your own financing?
So we need to evaluate your current position, both on the property and your personal position. The other thing that you may want to think of, why do you want a new property? Or, do you really want to keep your old property? Maybe you don’t want to do a 1031 exchange. Evaluate where you are and where you think you might want to go.
What kind of properties do you think you might want to buy? Do you want to go from single family rental to a industrial property or land? What would you like to do? One of the ways that you evaluate your current position is to look at what taxes you might pay if you just sold the property. You might not want to do a 1031 exchange.
Taxes you may pay when you sell a rental or investment property.
a. On a sale, you’re going to pay capital gains tax sometimes between 15 and 20 percent of your gain. Remember, this is not on your profit, it’s on your gain, which of course is an accounting term.
b. In a 1031 exchange, your capital gains taxes are deferred, sometimes forever.
c. In a sale, you would pay depreciation recapture tax up to 25 percent of the depreciation. And remember, you might not have even taken the depreciation.
It’s depreciation that you could have taken or you did take on your taxes.
d. In an exchange, your depreciation recapture tax is deferred, again, sometimes forever.
e. You may be responsible for 3.8% net investment income tax, sometimes known as a Medicare tax, and that is any gain that you have made above $250,000 in your current income. And that includes your regular income also, so this is real important to understand because it can be costly.
f. In an exchange, you can defer that tax, sometimes forever.
g. In some states you have a state capital gains tax if you sell.
h. But in a tax deferred exchange, it is deferred.
Okay, you’ve evaluated your current position. You know what your tax implications might be. You also know whether you want to stay in your same property or what kind of property you’d like to buy.
You also understand the difference between equity and gain. We talked about that in another video and it’s really, really important to understand.
4. Create some questions.
In this whole process, write your questions down. Now why are you writing your questions down? You’re doing this because you’re going to take it to your accountant.
5. Make an appointment with your accountant.
You are going to make an appointment and meet with an accountant. Now this is going to be an accountant who understands 1031 exchanges and has done them. Many accountants don’t really work on 1031 exchanges, so it’s important to find an accountant that does understand them so that you can get good advice.
Remember, you’re doing this 12 months in advance of your exchange, so you can use the advice properly.
6. Select your real estate agent(s).
Select your real estate agents depending on your goals, and make sure that your real estate agent has experience in 1031 exchanges. If you need help on that, I’ll be glad to help you find a real estate agent in your locale that knows 1031 exchanges.
This is an important process. You should interview them. So, are you ready to do your 1031 exchange next year? If you have any questions, Contact me because I will help you work through the process.