When someone realizes a profit from selling real property, there could be significant capital gains tax liability. However, selling and buying multiple properties is often a central part of real estate investment. Fortunately, a real estate investor can use a 1031 exchange to delay or defer capital gains taxes after a sale. Arizona real estate investors have come to depend on 1031 exchanges to maximize their profits and remain competitive. However, recent developments have caused some to ask: What is happening with 1031 exchanges, and how could it impact Arizona investors?
The 1031 Exchange
1031 refers to the IRS code section that permits a property owner to exchange one investment property for another. If an investor?s transaction meets all of the requirements, a property owner will owe few, if any, taxes after the sale or trade of real estate. The code views the investor?s transaction as basically changing the form of property without realizing a gain. The transaction is considered an “in-kind” exchange, and as long as the investor keeps investing their profits, they will not owe taxes on them.
The Current Rules for 1031 Exchanges
- 1031 exchanges only apply to real estate and are only allowed for investment properties. Therefore, you can’t use 1031 to trade one personal residence for the other and qualify.
- An investor can complete an exchange as many times as they like, but they have to follow the other applicable rules.
- To qualify for 1031 treatment, properties being exchanged must be of “like-kind.” The IRS considers properties ?to be of like-kind if they?re of the same nature or character, even if they differ in grade or quality.?
- Investors can realize profits from an exchange. However, the 1031 exchange process allows investors to defer paying capital gains taxes on the in-kind portion of the real estate transaction until they decide to stop reinvesting.
How do 1031 Exchanges Work?
- An investor sells his or her investment property, and then the money from the sale will be given to a designated intermediary.
- The seller has 45 days afterward to select another investment property and tell the intermediary.
- The owner can designate up to three properties, as long as he or she actually closes on one of them.
- The owner must close on the new investment property within 180 days of the prior sale.
- Any capital gains leftover after the sale are paid to the owner and are subject to taxation.
- Although you may profit from each exchange, this process allows you to defer paying taxes until you finally sell.
Are 1031 Exchanges Changing in Arizona?
Presently, there are not any planned changes for the federal tax code. The last amendment to section 1031 took place in 2017 with the U.S. Tax Cuts and Jobs Act. With the upcoming presidential election, there has been some speculation about possible changes to section 1031. ?According to a recent report, Democratic presidential nominee and former Vice President Joe Biden recently announced a $775 billion plan that would partly include reducing or eliminating 1031 tax breaks for real estate investors who earn more than $400,000 a year. Some have hypothesized that if former Vice President Biden is elected and the plan is approved and becomes law, Arizona real estate investors will buy fewer properties and sell properties and sell them at a slower rate.
Laura B. Bramnick is an experienced Arizona real estate attorney who has the expertise you need at every stage of your real estate transaction. If you are seeking an exceptional, client-driven real estate lawyer in Scottsdale, Phoenix, Sedona, and throughout the state of Arizona, contact Laura B. Bramnick to schedule your consultation.