• by The VRET Team

How VRET Can Assist You With a 1031 Exchange in OKC

If you are wondering, “what is a 1031 exchange?” keep reading to learn about the process of exchanging one piece of investment real estate property for another in a way that defers capital gains taxes.

The term 1031 exchange comes from Internal Revenue Code §1031. You must follow specific IRS rules to benefit from the 1031 exchange tax credits. These include requirements for the type of eligible property, time frames, and tax implications.

One of the key benefits of a 1031 exchange is your ability to build financial wealth through real estate investing. This guide explains how this method of real estate investing, where changing the form of your investment without recognizing capital gains, allows your investment to grow tax-deferred.

Key Takeaways of IRC §1031

The Internal Revenue Code §1031 applies to investment and business property. The property must be the same type of “like-kind.”

What you are doing is exchanging one property for another. When you make that exchange, the second property assumes the cost basis of the old property. This is a way of facilitating a reinvestment from one piece of property to another, as long as the property is a “like-kind.”

Like-kind means the property must have the same character or nature, even if they are of varying grades or quality. Any real property to conduct business, regardless of whether unimproved or improved, will usually qualify as being of “like-kind.”

The investor cannot use proceeds from the exchange to purchase another type of asset, such as bonds or stocks. The idea is that even if you profit after each swap, you can delay paying taxes until you sell the property for cash. Using expert market research you can achieve your long-term goal of only paying tax once at the long-term capital gains rate.

There is no limit on how many times you can do a 1031 exchange. Your investment wheel continues to grow as you roll over the gain from one real estate property to another property, and then another, and another.

Real Estate Investment Benefits

Serious real estate investors utilize diversification by market or type. Owning real estate in a single market or geographical area or several assets of the same kind may be risky. Using a 1031 exchange, you can diversify your holdings over different markets, reducing your risk of loss.

When investing, estate planning may not be something you consider, but the ability to maintain tax deferment throughout your lifetime leaves your decedents with a tax-free inheritance. Upon your death, those who inherit the real estate will receive the property on a stepped-up basis, meaning at the current fair market value at your death. The capital gains you defer until the sale are eliminated permanently.

Leverage up by using the 1031 exchange to sell a property for one in a better location or of higher value. You increase your purchasing power and wealth by obtaining replacement property using funds from your sales. The more equity you own, the better loan-to-value ratio you can secure when seeking approval for higher-value property loans.

Management relief is available if you are holding property that is taking too much time. This may be problem tenants, repairs, maintenance issues, etc.

If you want to change to a property with fewer problems, you can use a 1031 exchange to transfer up to a higher-value property. This provides you with a better quality of life, increases the value of your investments, and allows for greater growth potential.

Relocation may become necessary due to a job change or retirement. Using a 1031 exchange to sell your real estate in one location and purchase in another makes it easy to grow your net worth wherever you live.

1031 Exchange Rules

One of the main qualification requirements for 1031 exchange properties, is that both properties must be within the United States. In a 1031 exchange, the new property must be of equal or greater value than the property you sell. To receive a full tax deferral, 100% of the proceeds from the sale must be used in purchasing the second property.

If you sell a piece of real estate for $300,000, you can’t reinvest $200,000 and take the remaining $100,000 for yourself or use it for alternative investments. If the total $300,000 is not used in the second transaction, or the second property is not of equal or greater value, capital gains apply to the entire gain.

When you are exchanging depreciable property, you may trigger depreciation recapture. This can happen if you exchange unimproved land (no building) with improved land (with a building). The depreciation you previously claimed on the building may experience recapture as ordinary income.

In the past, franchise licenses, equipment, and aircraft could be exchanged under 1031. The Tax Cuts and Jobs Act (TCJA), effective December 2017,  removed those items. Now only real property or real estate is eligible.

To be of a ‘like-kind” for the exchange, the property being sold must be for business or an investment, and the exchange must be with another property for business or investment property, making it a “like-kind.”

Partnership interests and corporate stock were never eligible for 1031. Interest as “tenancy in common” does qualify.

This happens when two or more people share real estate property or land ownership.

When owners share “tenancy in common,” there is no right of survivorship. If a tenant ties their portion of ownership passes to their estate.

1031 Exchange Timeline

Because it is unusual to find a piece of property you want at the same time someone wants the property you have available, most 1031 exchanges become delayed, three-party, or Starker exchanges.

The critical thing to remember is that two timelines, a 45-day, and a 180-day, run concurrently. If you miss either deadline, even by one day, you are liable for capital gains on the first transaction.

Delayed Exchange

A delayed exchange requires a third party to take possession of the cash after you sell your property. They hold the funds until you locate a replacement property. That middleman then uses your money to purchase the replacement property.

To meet the timeline requirements, once your property sells, the middleman must receive the cash. You cannot accept the money, or it will no longer qualify for 1031 status. Within 45 days of your property selling, you must instruct the intermediary in writing the replacement property you want to obtain.

The IRS does allow some leeway with this. You can designate up to three properties, but you must eventually close on one. 

The other timeline rule you must follow is that the closing on your new property must occur within 180 days of when you sold your property. The 45-day rule and 180-day rule run concurrently, so the timeline on both begins on the date you sell our property.

If there is any cash remaining after the middleman obtains the replacement property, they will pay you the difference after the 180 days expires. This cash is known as boot. The boot is taxed like partial sales proceeds, usually as a capital gain.

You must consider any outstanding loans on property you sell or purchase. If your liability goes down, but you do not receive cash back, the IRS will treat that difference as income.

For example, you have a $2 million mortgage on your old property, and the mortgage on your new property is only $1,800,000. In this case, you have a $200,000 capital gain, classified as a boot. You will be taxed on this boot.

Reverse Exchange

If you purchase the replacement property before the old one sells, you can still qualify for a 1031 exchange. You need to transfer the new property to an exchange accommodation titleholder. They must identify your property as available for an exchange within 45 days and complete the sales transaction within 180 days of the new property purchase.

Vacation Home Exchanges

Congress tightened the loophole allowing people with vacation homes to swap for other vacation homes, enjoying a delayed recognition of gain. To enjoy that loophole now, you must stop personal use of your vacation home and rent it out for a minimum of six months.

Securing a tenant and handling the transaction as a business allows you to convert your vacation home into an investment property. This should then meet the qualifications as a 1031 exchange.

You must have tenants to meet the qualification for 1031. Just offering the property for rent without securing tenants disqualifies you from 1031.

Moving Into a Swap

You cannot move in immediately if you obtain a home in your swap that you want to use as a second or principal home. The IRS 2008 Safe Harbor Rule states that it will not challenge a 1031 qualification that meets the following:

During each of the two 12-month periods following the exchange:

• The home is rented to another person at a fair market rental rate for a minimum of 14 days, and
• You do not personally use the home for more than the greater amount of 14 days or 10% of the number of days during that same 12-month period the unit was rented to someone else

If you convert the exchange property to your principal residence, you cannot take the $500,000 exclusion during the five years following the date of property acquisition.

1031 Exchange Tax Credits

The main benefit of conducting a 1031 exchange is the tax deferral. Rather than selling an investment property, purchasing another, and incurring capital gains, use this swap method to defer capital gains.

You can reset your depreciation on your property for deterioration due to wear and tear, aging, structural obsolescence, etc. The depreciable time for investment property is 27.5 years under IRS rules.

Every tax year, the amount of your investment in the property is divided by 27.5 years, which can be deducted from your taxes during that time. This means that in addition to deferring your capital gains, you can receive a depreciable tax break on your taxes.

When you conduct a 1031 exchange, you must notify the IRS using Form 8824 and file it with your tax return. You will need to provide a description of the property you exchanged and the dates of identification and transfer.

The form requires disclosing your relationship with the other parties you exchange property with. You must provide the value of the like-kind properties, the adjusted basis of the property you give up, and any liabilities you assume or relinquish. If you do not complete this form correctly, you may receive a large tax bill and penalties.

VRET offers a series of five videos that explain the basics of using 1031 tax-deferred exchanges. The videos provide information on how to avoid paying taxes on rental property sales and using the money to increase your wealth. The information increases your understanding of how to avoid costly mistakes when taking advantage of these tax credits.

1031 Estate Planning Advantage

One good thing about 1031 exchanges is that tax liabilities end with death. If you die without selling the property, those who inherit the property will not have to pay the taxes you postpone paying. They will inherit the property at its market-rate value.

Real Estate Investing in Oklahoma City

Oklahoma City is experiencing a tremendous amount of growth and opportunity. This makes it the perfect location for real estate investing.

Numerous districts offer hotels, meeting spaces, and more. Oklahoma City is full of friendly, welcoming people, making it a “go-to” spot for everyone.

When investing in real estate, you want a city popping with activity. Your ability to make a profit and see good 1031 exchanges requires versatility, and you’ll get it here.

When seeking assistance in handling your 1031 exchanges, you need a company with vested experience and a proven track record of success. You want someone who knows the ropes of investing and will guide you in meeting your goals, including buying, processing contracts, finding a property management company, and more.

Buying and selling business properties using the 1031 exchange method requires knowledge of current laws. Work with a company that stays current on rules as they change and who will make sure you cross your t’s and dot your i’s to avoid costly tax penalties. 

Where to Find 1031 Exchange Assistance

Using the 1031 exchange is a great way to achieve financial wellness. To be successful, make sure you meet all the IRS requirements. The best way to guarantee success is to secure the help of the Virtual Real Estate Team (VRET).

At The Virtual Real Estate Team, we help you create a plan to grow your wealth through real estate investing in Oklahoma City. Learn more about how we can help you achieve financial growth by scheduling an appointment for your first meeting with our team.