Things To Know About 1031 Exchanges

In Alabama, a 1031 exchange refers to swapping one real estate investment property for another within a certain time period to defer capital gains tax. The term originates from Section 1031 of the Internal Revenue Code (IRC) and has several nuances, which are covered within this post. It is recommended that you speak with an experienced real estate attorney in Alabama to be clear on the time frames and tax implications.

Overview of IRC Section 1031

In general, a 1031 exchange is also called a Starker exchange or a like-kind exchange. It involves swapping one investment property for another. Property swaps are looked at as sales by the IRS, which means taxes. Moreover, if it meets the requirements of section 1031, you will either have limited tax or no tax at all on the transaction.

Basically, you may be able to change the form of investment without creating any capital gain. Your investment will continue to grow tax-deferred. The best part is that there is no limit on the frequency of 1031 exchanges. You can easily roll over the gain from one investment property to the next and so on.

Even though you are earning profits on each swap, you aren’t really paying any taxes on the increase in wealth. The only time you pay taxes is when you cash the property many years later. You may end up paying 15 – 20% (current rates as of 2022) as a one-time long-term capital gains tax. There is a 0% tax for lower-income taxpayers.

Applicable Rules for Depreciable Property

There are special rules that come into force when the swap is for a depreciable property. Depreciation recapture is a form of profit that gets taxed as ordinary income.

You may be able to avoid this recapture by swapping one building for another. Moreover, if you end up exchanging improved land that has a building for a piece of land that doesn’t have a building, the depreciation claimed previously on the building will be recaptured as ordinary income.

These complications related to the 1031 exchange are why you should work with a real estate attorney that understands the ropes.

Timelines and Rules Regarding 1031 Exchange in Alabama

An exchange classically involves simply swapping one property for another. In relation to this, it can be difficult to find someone else that wants the exact same property as yours. This is why most exchanges are delayed.

Delayed Exchange

You need a middleman or a qualified intermediary in a delayed exchange. This professional holds the cash on the sale of the property and uses it to buy a replacement. Swap refers to this three-party exchange.

A delayed exchange has two key timing rules that need to be observed:

• 45-day rule: This regards the designation of the replacement property. The intermediary will receive the cash once the property sale occurs. The 1031 treatment will be spoiled if you receive the cash. You will also have to designate the replacement property within 45 days of the sale. This needs to be in writing to the intermediary. It should specify the property you are looking to acquire.
• 180-day rule: The new property needs to be closed within 180 days of the sale of the old property.

Reverse Exchange

You can always purchase the replacement property before selling the existing one to qualify for a 1031 exchange. The same time windows (45 days and 180 days) apply in this case. You need to transfer the new property to an exchange accommodation titleholder, identify the property exchange (45 days), and complete the transaction (180 days).

Tax Implications Related to 1031 Exchange in Alabama

It’s possible to have cash (known as boot) left over once the intermediary acquires the replacement property. The intermediary will pay the cash once the 180 days window is over. This boot will be taxed as partial sales proceeds or capital gain from the sale of the property.

Don’t forget to consider loans when considering such transactions. You need to look at all debt on the property, including mortgage loans. You need to relinquish existing debt and take a look at the debt on the replacement property. If your liability goes down, but you don’t receive any cash back, it will be treated the same as income.

Estate Planning with 1031 Exchange

Tax deferral eventually comes to an end with 1031 exchanges, and this is when you are hit with a big bill. In relation to this, tax liabilities end with death. Your heirs will not be expected to pay any taxes on the property. They can inherit the property at the stepped-up market value without any tax implications. This makes a 1031 exchange ideal for estate planning.

Speak with a Reputable Real Estate Attorney in Alabama Today

Savvy real estate investors can use the 1031 exchange as a tax-deferred strategy for building wealth. The experienced attorneys at the law office of Davis, Bingham, Hudson & Buckner, P.C. can advise you on the best course of action to save taxes while increasing your wealth.

To schedule your free, no-obligation consultation, call us at (334) 458-8192 or complete this online contact form.