Video - Is a 1031 Exchange a Zero-Sum Game?

Many people ask, “is 1031 a zero-sum game?” In other words, do you have to do a 100% tax-deferred exchange? What if you want to take some boot and recognize some gain? Can you do a partial 1031 exchange of real estate?

The answer is yes, you can do a partial 1031 exchange. You don’t have to reinvest 100% of your sales proceeds into the replacement property, nor do you have to buy a replacement property of equal or greater value. If you’re comfortable doing a lesser exchange (not deferring all of your gain), you can do that!

In a 1031 exchange, you defer gains dollar for dollar to the extent that you buy replacement property of a value greater than your transferred basis. So if you sold a property and your basis in the relinquished property was $300,000, and then you bought a replacement property, your old basis of $300,000 transfers over to the new property. You only start deferring gains to the extent that you’re buying value over and above your transferred basis. So if your new replacement property is worth $500,000 then you’ve only deferred the gains on $200,000 because the first $300,000 was absorbed by your transferred basis.

Anytime you do a partial 1031 exchange you may be amazed that there is a tipping point at which it may not make sense to do an exchange because you bought down in value so much that you recognized most or all of the gains you had. Any significant amount of boot or buying down in value on your replacement property should be discussed with your accountant. You should get an idea of how much you’re deferring in tax as opposed to how much you’re recognizing and paying in tax liability by doing that partial 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

2 Reasons Why It May Not be Beneficial to Park Your 1031 Exchange Replacement Property

In this article, we are going to talk about why it may not be beneficial to park your 1031 exchange replacement property in a holding company.

Financing

Depending on the details of your exchange, the financing may be too complicated to have a 1031 exchange accommodation titleholder acquire your new replacement property. It might simply be unfeasible to get it through the financing committee if lenders are uneasy.

Tax Incentives

Tax incentives are another reason why it might not be to your benefit to park your replacement property in a holding company. For example, there may be low income tax credits that might incentivize you to get into the new replacement property quickly.

Contact CPEC1031

The qualified intermediaries at CPEC1031 have been conducting real estate 1031 exchanges for decades. We bring our extensive experience to the table for every like-kind exchange we facilitate. Contact us today to learn more about our 1031 exchange services and let us help you get your exchange off the ground. Our main office is located in Minneapolis, MN but we provide services to clients throughout the United States.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

What to do if Your 1031 Exchange Straddles Two Years

We get calls from people all the time who have already completed the sale of their property and want to set up a 1031 exchange after the fact. Unfortunately, once you’ve completed the sale of your property, the opportunity for an intermediary to set up a 1031 exchange has expired. In other words, you can’t set up a 1031 exchange after the fact. This just emphasizes the importance of preparation and planning when it comes to 1031 exchanges. You have to get all of your ducks in a row before the closing of the relinquished property.

1031 Exchange that Straddles Two Years

Let’s say you are looking to sell a property in late December. If you sell that property and put your proceeds with a qualified intermediary intending to do a 1031 exchange, but the exchange fails in the subsequent year (perhaps for failing to identify a replacement property). When a 1031 exchange straddles two separate years like this, there are certain details that need to be considered. There is some nice interplay between code section 453 (the installment tax rules) and section 1031 that would allow you even in a failed 1031 exchange to defer those gains on the receipt of the cash that’s not received until the subsequent year. So even if you’re on the fence about whether or not to do a 1031 exchange at the end of a year, it may be beneficial to set up a 1031 exchange to keep the option open to at least get a 1 year tax deferral.

Benefits of 1031 Exchanges

At CPEC1031, we focus on helping owners of real estate defer their taxes when selling appreciated real estate. When selling real estate, your gains can come from the natural appreciation that occurs over time or from depreciation deductions that whittle down your basis over time. The goal with a 1031 exchange is to defer your gains and keep that money that would otherwise go off to the state or federal government and use that money to compound and build your wealth over time.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Reverse 1031 Exchanges in a Rising Interest Rate Environment

When you do a 1031 exchange you’ve only got 45 days after the closing of your relinquished property to identify your replacement property and 180 days total to complete the exchange. That rule was created by the IRS, with power granted by Congress to write the treasury regulations. With this time frame, the IRS was trying to constrain the number of people completing 1031 exchanges. These identification deadlines are hard and fast. Unless you’re impacted by a federally declared disaster, these are unwavering deadlines.

Reverse 1031 Exchange Benefits

So what are savvy real estate investors doing to avoid a potential failed 1031 exchange? They’re finding their replacement property first, and lining up a sure thing whenever possible. This is otherwise known as a reverse 1031 exchange.

Logistically some sellers are entering into a purchase agreement with their buyer and saying “buyer, I’m happy to sell to you at this price, but I as the seller get to control the closing date.” This allows the seller to hold off on the closing until they’ve got a replacement property lined up. That works great when you’re not in a rising interest rate environment. But right now, we are in a rising interest rate environment where banks are not going to let potential borrowers get a rate lock for a long period of time. As a result, there is often a tension between the buyer and seller where the buyer is chomping at the bit to close the deal and the seller is reticent to take the plunge until they have a sure thing lined up.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

How Do you Calculate the Amount of Deferred Gain on a Partial 1031 Exchange?

In a partial 1031 exchange you’re only deferring gains to the extent that you’re buying replacement value over and above your transferred basis. Let’s say you sold a relinquished property for $2 million but you had a $250,000 remaining basis in the relinquished property. The first thing that happens when you buy a $1 million replacement property is that your $250,000 basis transfers over to the new acquisition, and you only defer gains over and above that transferred basis.

A partial deferral is better than no deferral at all but it’s not optimal. The best course of action to do a full 1031 exchange is to plan things out and make sure you have enough replacement property to defer all of your gains.

Can I Sell a Relinquished Property Worth $2 Million & Acquire a Replacement Property Worth $1 Million?

The answer depends on how low your basis is on your relinquished property. The first thing that happens when you do a 1031 exchange is that your old basis transfers to the new property. You only really start deferring gains to the extent that you buy real estate over and above your transferred basis. So if your basis was zero (you have a $2 million gain and you buy a $1 million replacement property) you’re going to defer half of your potential gain. This is what’s known as a partial 1031 exchange.

There are a few ways to fix that issue. One is to identify multiple replacement properties and close on enough of those properties so that you’re deferring all of your gains. The other is to do a build-to-suit exchange and construct improvements on that property using your exchange funds.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved