Gain 1031 Exchange Company

December 2011 Newsletter

In December, 180 Days May Not Be 180 days     

If a 1031 exchange is completed later in a tax year, such as in December, an exchanger should be aware that the usual 180 days to complete an exchange may be shortened.

The exchange rules state that the acquisition of a replacement property must be completed within 180 days OR the due date of the exchanger’s tax return for the year in which the relinquished property was sold. Thus, this time period may be shortened if the due date for the taxpayer’s tax return falls within the 180 days. For example, if a taxpayer sells a relinquished property in December that taxpayer must complete the exchange before the due date of the taxpayer’s tax return (April 17^th for individual returns in 2012) which is substantially less than 180 days.

However, if the full 180 days is needed, a taxpayer can file for an extension of time to complete their tax return.

Can you sell a property with no equity and still pay tax?

The answer to the question lies in the often misunderstood distinction between equity and capital gain.  Equity is the difference between the market value of the property and the financing encumbering the property. Capital gain is the difference between the amount realized on the sale and the adjusted basis.

It is possible to sell property, pocket no funds from the sale and still have tax due. This occurs when the property value falls to a level below the dollar amount of the financing on the property. In that case, there is no equity in the property and the seller will not receive any money from a sale. However, that doesn’t mean that there is no taxable gain. 

Every piece of property has a basis. A property’s basis is a complex calculation which begins with the initial basis which is usually the purchase price. Then during the life of the property, the basis changes primarily when capital improvements are added in and deductions are subtracted out to produce the final number used in the equation.

The amount realized on a sale is roughly the sale price less sale costs.

For example, if a property is purchased for $100,000 and sold for $150,000 the taxable gain is $50,000. In this example, if the financing on the property is also $150,000 the property has no equity. Upon a sale the seller will receive no cash however, there is still taxable gain.

This is an important distinction when considering the tax consequences of a property sale and possibly completing a 1031 exchange in order to avoid the tax payment.

When Should a Person or Company Consider a 1031 Exchange?

A 1031 exchange is a process authorized under Section 1031 of the tax code that allows for a seller of property to avoid the payment of capital gains tax which would otherwise be due upon selling the property.

There are many factors that must be considered to determine if an exchange will work for any seller, however, the two primary questions to answer are:

1)      Will there be capital gains tax due upon selling the property? and

2)      Do I want to purchase a replacement property?

If the answer is yes to both of these questions, then a 1031 Exchange is an excellent tax avoidance tool. The purpose of doing a 1031 exchange is to defer payment of tax upon selling business, commercial or investment real estate. The tax deferral occurs when the seller “rolls” their investment into a replacement property by utilizing a 1031 exchange. Since the seller doesn’t cash out their investment, they are able to avoid recognition of any tax due upon the sale.

Anyone considering an exchange should answer question one by calculating the amount of capital gain that will occur upon selling the property. The calculation of gain is done by subtracting the adjusted basis of the property from the amount realized upon selling the property. If that calculation results in a gain, then that gain is likely taxable and a 1031 exchange should be considered to defer payment of that tax. The basis in a property is loosely defined as the amount paid for the property (less any allowed depreciation). The amount realized is the amount of the sale price. For example, if a property is purchased for $300,000 and sold for $400,000, then there is $100,000 in gain. This gain is likely taxable.

Then comes question number two. The key part to a 1031 exchange is the exchange component. In order to defer the tax under section 1031, the seller must “roll” over their investment into other business, commercial or investment real estate. If the seller is interested in continuing to own real estate then a 1031 exchange is an excellent tax deferral tool.

A 1031 exchange Qualified Intermediary is key to the process of a 1031 exchange and can provide further information on how exchanges work.

Please contact us if you have questions

info@gainexchangecompany.com