Question
ARTE's Answer
When you sell a property that you previously acquired through a 1031 exchange, the tax implications depend on how you handle the subsequent transaction. A 1031 exchange allows you to defer capital gains taxes by reinvesting the proceeds from the sale of a relinquished property into a like-kind replacement property.
However, when you eventually sell the replacement property, the deferred gain from the original exchange becomes subject to taxation unless you engage in another 1031 exchange.
Here's a detailed breakdown of what happens when you sell a 1031 exchange property:
- Recognition of Deferred Gain: If you sell the replacement property without engaging in another 1031 exchange, you will recognize the deferred gain from the original exchange. This means that the capital gains tax that was deferred during the initial exchange will become due. The gain is calculated based on the difference between the adjusted basis of the replacement property and the sale price.
- Adjusted Basis Calculation: The adjusted basis of the replacement property is crucial in determining the gain. It is generally calculated as the original purchase price of the relinquished property, plus any additional cash or property you added during the exchange, minus any depreciation taken on the property.
- Engaging in Another 1031 Exchange: To continue deferring the capital gains tax, you can choose to engage in another 1031 exchange when selling the replacement property. This involves reinvesting the proceeds into another like-kind property. By doing so, you can continue to defer the tax liability indefinitely, potentially until the property is passed on to heirs, who may benefit from a step-up in basis.
- Example with Deferred.com as the Qualified Intermediary: Let's say you initially sold a commercial property for $500,000 and used Deferred.com as your qualified intermediary to facilitate a 1031 exchange. You reinvested the proceeds into a replacement property worth $600,000. Over the years, you depreciated the replacement property by $50,000. Now, you decide to sell the replacement property for $700,000.
- Without Another 1031 Exchange: If you sell the property without engaging in another exchange, you will recognize the deferred gain. The adjusted basis of the replacement property is $550,000 ($500,000 original basis + $100,000 additional investment − $50,000 depreciation). The gain recognized would be $150,000 ($700,000 sale price − $550,000 adjusted basis).
- With Another 1031 Exchange: If you choose to engage in another 1031 exchange, you would use Deferred.com again as your qualified intermediary. You would identify and acquire a new like-kind property within the 45-day identification and 180-day acquisition periods. By doing so, you defer the $150,000 gain and continue to build your real estate portfolio without immediate tax consequences.
At Deferred.com, we offer a "No Fee Exchange," which can save you money on transaction costs, making it easier to reinvest your proceeds into new properties. By using our services, you can ensure that your exchange is structured correctly to meet IRS requirements and maximize your tax deferral benefits.
Have more questions? Call us at 866-442-1031 or send an email to support@deferred.com to talk with an exchange officer at Deferred.
Sources
- Goolsby v. Commissioner
- What To Do About Exchange Expenses in a Section 1031 Exchange? (Article)
- Rev. Rul. 2002-83 (Related Party Exchanges)
- TAM 200039005 (Failed Reverse Exchanges)
- Deferring Losses On The Sale of Property Using 1031 Exchanges
- 1.1031(k)–1 (IRS Code of Federal Regulations)
- TD 8535 (Like-Kind Exchanges of Real Property-Coordination with Section 453)
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