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Tag Archive: 1031 Tax Exchange

  1. Leveraging Real Estate Gains: The Power of a 1031 Exchange

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    Nine out of 10 US millionaires have found tremendous financial success in real estate investment. Read the seven reasons why 90% of millionaires choose to invest in real estate and why you should too in this article.

    The federal government’s rules and regulations offer favorable incentives including annual depreciation and interest expense deductions. These tax deductions encourage investors to deploy money into real estate. The most favorable, generational wealth building tool can be found in Section 1031 of the IRS code. According to,

    Whenever you sell a business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange.

    A 1031 exchange allows a real estate seller to defer paying taxes so he or she can leverage capital gains into a larger asset with presumably greater cash flow. The IRS essentially allows an investor to ‘kick the can down the road’ and reinvest the government’s money via a 0% interest loan. The taxes do not disappear, but an investor has the opportunity to leverage the government’s money into larger assets. The 1031 program rewards investors while encouraging further investment in real estate.

    This is one of the greatest wealth building tools that exists, because there is no limit on the number of times an investor can utilize a 1031 tax exchange. The federal government is also flexible on the definition of a like kind property. For example, you can sell an apartment building and purchase an office building, land, industrial building, or an asset in a different sector of real estate. To qualify for a 1031 like-kind tax exchange, there are important rules and regulations that must be met. Identification timeframe and the process are two key items to understand.

    The government offers two primary identification methods for a 1031 exchange. Both methods require the seller to utilize an intermediary to quarterback the process. Some intermediaries specialize in only 1031 transactions. Other investors choose to utilize their preferred real estate attorney, whose firm is capable of handling a 1031 transaction. To execute a 1031, it is imperative the exchanger (seller of relinquished property) hire an intermediary who handles the 1031 transaction, before the relinquished property closes. A 1031 is considered null and void if the seller (of the relinquished property) takes position of the funds from the relinquished asset sale. More information about the top ten identification rules for a 1031 exchange can be found here.

    The traditional 1031 method allows for a 45-day requirement to identify and designate property to purchase, once the relinquished property has sold. There are two “identifying” rules that govern how many properties can be identified. The first rule allows an exchanger to identify up to three properties to purchase. The second method allows an exchanger to identify as many properties as desired, up to 200 percent of the value of the relinquished asset. The second timeframe rule pertains to total days to purchase the replacement asset(s). From the sale of the relinquished asset (property sold), you have 180 days to finalize a transaction to purchase a replacement property or properties.

    The second method to execute a 1031 occurs when the exchanger buys “replacement assets” before the relinquished property is sold. A reverse 1031, as implied, is effectively the reverse order of a traditional 1031. This option takes more time and is more cumbersome from a paperwork/process standpoint. The replacement asset(s) are purchased first and held by an intermediary. Then, the 1031 applicant has 180 days to close on the asset. Why would anyone utilize a reverse 1031? Black Diamond Realty recently experienced a situation, whereby a client secured a purchaser for a parcel of land and the client wished to defer capital gains tax payment. So, the client secured two replacement properties via a purchase and sale agreement. The land contract needed to be extended multiple times. After six months, the seller of the replacement assets (our client was the buyer) applied pressure for the multifamily properties to sell immediately. In addition, our client wanted to close on those assets, because we were in a rising-interest-rate environment. Our client closed on the two multifamily “replacement assets” before finalizing the sale of his land (cause for the capital gain to be in play), resulting in a reverse 1031 being executed.

    Black Diamond Realty recommends you consult with your accountant or tax advisor and a real estate attorney before finalizing your like-kind exchange strategy. BDR has many on-market and off-market replacement opportunities. So, please utilize our team as a resource. Wealth building tools have been created to incentivize folks to invest in real estate. Be aware of their availability and utilize them to meet your investment goals.


    Article written by:
    David Lorenze, Principal







  2. What To Know About 1031 Tax Exchange

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    At Black Diamond Realty, one of our goals is to educate our clients and help them build wealth over time via real estate investments and holdings.

    Tremendous perks exist in real estate that are not available through investing in stocks, bonds or other investments. One of those major perks is a 1031 tax exchange. A 1031 tax exchange can be described as a real estate transaction without immediate tax implications to the seller.

    It is important for you to understand your tax bracket and effective tax when completing a 1031 transaction. You do not simply sell an asset and walk away with the net amount on the closing statement. Your transaction is, most likely, subject to capital gains and depreciation recapture. We recommend all clients consult their accountant to better understand the ins and outs of their tax liability associated with any contemplated transaction. With that disclosure in mind, consider how a seller’s capital gains tax liability is one wealth building tool permitted by the federal government.

    In a traditional transaction, the seller is subject to capital gains and depreciation recapture. This article is only focusing on capital gains. A capital gains tax is defined as a tax on the increase in the value of an investment.  Short-term capital gains are characterized as gains from a sale in which an asset was owned for less than one year. Short-term capital gains are taxed according to your income tax bracket (seven total tax brackets in 2018).  Long-term capital gains are classified as monetary gains in which an asset was owned for more than one year.

    For single filers, the capital gains tax rate ranges from 10% to 37% for short-term capital gains versus 0% to 20% for long-term capital gains. Check out the charts (single versus joint filing) to get a better understanding of your potential capital gains tax obligation if you sell real estate. In addition to the capital gains tax outlined in the chart, high earning individuals (making $200,000+ filing individually or $250,000 filing jointly) are subject to an additional 3.8% tax which the government calls the “net investment income tax”.

    So, you may be saying, “I get the tax percentages and know where I fall, but how do the numbers look in a real-world example? And, is there any way I can defer these taxes?

    Let’s take a look at an example. You are successful entrepreneur who found an office building for $500,000. Over the years, the asset increased in value as the economy grew and the market improved. Seven to eight years (average hold on a commercial asset) after your initial purchase, you agree to sell the asset for $1,000,000. In this example, you are facing a capital gain of $500,000. (The basic formula for calculating your capital gain is to take the basis sale price minus the property’s basis (purchase price +/- depreciation, amortization, improvements and selling expenses). The net amount is your capital gain.)

    Review the chart above to see what your tax liability would be. We will assume the top capital gains tax rate of 20% plus the 3.8% (net investment income tax). In this example, your federal capital gains tax would be a total of 23.8% which is $119,000. That’s right… $119,000! So, your gain goes from $500,000 down to $381,000. This sounds like a lot of money but your accountant will remind you that is not the money you get to keep. Your accountant will need to give you the calculation for the depreciation recapture you owe. The term is exactly as it sounds… You need to recapture the “paper write-offs” you have been taking over the years, via “depreciation” tax reductions and repay them. Whew, are we done? Not yet. You also need to remember state taxes will apply. Having a trusted real estate accountant is a must when investing in real estate.

    You may have been thinking this entire article was slated for doom and gloom. But, what if there were a way you could defer those taxes and continue building your portfolio, tax deferred? Section 1031 of the federal government’s tax code permits a seller to complete a like-kind exchange (real estate asset to real estate asset) in which a replacement property is purchased within 180 days. Completing a 1031 like-kind exchange, often referred to as “1031” or “like-kind exchange,” allows you to roll all of the proceeds of your sale into a “like-kind” asset.

    In the sale example used above, a 1031 exchange would allow you to roll the $500,000 into another asset without paying the $119,000 in capital gains tax. Over time, this strategy could allow you to “scale up” into larger assets public, in broad strokes, on the subjects of capital gains tax and 1031 exchanges that produce greater cash flow and potentially greater returns. Completing a 1031 transaction requires the participation of a real estate attorney who specializes in that process.

    Please remember to consult your accountant and real estate attorney to better understand your personal options.

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