Due to the rise in home values, when it comes time to sell the property, your clients may be facing some hefty tax consequences and want to roll their capital gains from one property into another one. Some of these are preventable with a little strategic planning; others may not fit within the IRS Code parameters for taxable exposure.
Lately, I’ve heard “We’re going to just do a 1031 exchange” as a tax-savings approach. It’s important to note what it takes to qualify for a 1031 exchange, as well as how to ensure that your clients – if they do qualify – do not exempt themselves because of a mishandling of the funds, or blow timelines that they didn’t know about.
I’ve outlined some basic bullets for you and your clients to consider. Note that I am not a tax professional, and for anyone interested in pursuing a 1031 exchange, I cannot overemphasize enough the importance of consulting with a qualified tax professional – especially in a divorce proceeding that makes these transactions even more complicated.
Basic rules of 1031 Exchanges
- Only pertains to investment properties.
- Does not apply to primary residences or vacation homes unless they can qualify as an investment under a very small sliver of exceptions.
- Property must be exchanged for a “like for like” property, which means another investment property must be purchased, not a primary residence (again, a few exceptions apply).
Process
- Identify a replacement property within 45 days of selling the relinquished property, in writing.
- Sale must be complete on the replacement property within 180 days after the sale of the relinquished property is completed or the due date of the income tax return.
- The funds from the relinquished property cannot be touched by the principal. A qualified intermediary or exchange facilitator must handle the exchange of funds.
Divorce Considerations
- Title – the replacement property must be purchased in the same taxable entity. So if a couple holds joint title to their rental property and choose to do a 1031 Exchange, they must purchase the new rental property together.
- However, 1041 of the IRS Code pertains to tax-free transfers from one spouse to the other. Although not ideal, this could be a round-about way to accomplish a tax savings. Your clients should be working directly with an experienced tax professional to guide them through this.
- If one party wishes to move into their rental property after the divorce, there are a few things to keep in mind:
- If that property was acquired as a 1031 exchange, there are rules that they need to comply with
- If they did not acquire their rental property as a 1031, they should consider the tax consequences of converting the characterization of that property from a rental to an owner-occupied, especially if they plan to sell it in the future.
You may refer your clients to the IRS Fact Sheet for 1031 Exchanges for more information. They should also be working with a qualified real estate professional who understands the intricacies of these transactions to ensure they are in compliance with timelines and guidelines.
If you have a case with real property issues or one that needs to be listed, give me a call at the number below or send me an email – I’m happy to help!
All the best,