1. R24 WINE COUNTRY REAL ESTATE • SUNDAY, JUNE 21, 2015
Mike Kelly
Office: 707-206-4507
Mobile: 707-322-8503
BRE#0645724
Keller Williams
120 Stony Road, Santa Rosa, 95401
TheRealEstateHourBlog.com
email: mike@mikekelly.com
One of Sonoma County’s Natural Resources
Protecting Real Estate Equity: Is IRS 1031 Right for You? (Part I)
By Mike Kelly, Keller Williams Real Estate
Real estate investors often ask if they should
sell and take a capital gains hit (which can be
substantial,) or exchange out of their income/
investment property into a more lucrative real
estate position. It depends! If there is a need
for “cash” and you can afford to take the big
hit of capital gains then by all means consider
selling and using your cash as needed.
However, if you wish to build long-term
wealth, using the IRS 1031 Exchange
is a fabulous vehicle to see your equity
grow. (Check with your tax professional
on all financial matters regarding
capital gains and the right steps for tax
avoidance.)
Using a 1031 exchange does not
eliminate your taxes but defers them
far into the future. You can use the
proceeds of the sale of the investment
property to buy more “like-kind”
investments. We won’t go into all
the myriad details as to what can be
exchanged in this IRS code. (Again,
definitely talk to your tax pro.) The
key is the property proceeds must be
used to acquire “like-kind” investment
properties; a small rental can be
exchanged into land, commercial,
multiple units, etc.
Retiring boomer investors thinking of
gradually liquidating their holdings need
smart tax strategies. When investors say they
don’t mind paying capital gains taxes we
ask them how long would it take to save
the money they’ll be paying Uncle Sam. Not
“earning” but “saving.” This makes every
investor pause and re-think their strategy.
One strategy of a 1031 Exchange is to
back-track your investment strategy. Say you
owned single family homes over the years and
exchanged into a duplex, then to a 4-plex,
next a small apartment building. You have
big equity through appreciation and loan
payoff and are thinking how to get to “cash”.
Some back-track and exchange into many
single family dwellings. For tax purposes this
might be a smoother transition for your heirs.
Instead of leaving a large property which will
have to be sold, you can leave a child one of
the single family houses. This avoids clashing
siblings as one will want to hold and one
will want to sell. Also, if you now have say,
five single-family homes, you may wish to
sell your big primary residence and take your
$500,000 tax deferred home sale and then
move into one of your investment properties.
Live there two out of the five years and sell
and take your big tax deferral again.
A 1031 Exchange is a fairly straight forward
process. It does have some tricky timelines
and, in this highly constrained listing market,
can be very difficult to pull off. You need
cooperative buyers of your “relinquished”
property and know the timelines associated
with a successful 1031 Tax Deferred
Exchange. The time-line begins when
you close escrow on the property you are
exchanging “out of.” Once you close you have
180 days to complete the exchange but within
that 180 days runs the 45 day “identification”
period. You absolutely must identify your
move up property midnight of the 45th day. If
not—not-so-happy capital gains to you.
Many investors wish to exchange up and
are seeking the elusive 10 to 20 units here
in Sonoma County. They are shocked when
they go looking only to find the well dry for
this type of property. When selling
you should be able to negotiate a long
term escrow in which to identify your
move up property. Remember, you
can exchange into a commercial strip
center, office building, land, etc., as
long as it is held for investment and it
can be anywhere in the U.S.
Keep in mind the 45 days is for
identification only, and doesn’t mean
you need to close on the deal. Also,
you’ll need a “qualified intermediary”
to hold your sale proceeds. The
1031 Exchange prohibits you from
personally receiving the proceeds
of your exchange. Hence the reason
for the intermediary receiving sales
proceeds and not you. Be very careful
and do your research! I had a client
who got some horrible advice from her
accountant and took her proceeds and
placed them in a savings account. He told
her it was okay since she wasn’t using the
money while in the process of the exchange.
Absolutely killed the deal for the tax-deferred
nature of the exchange.
In Part II, we’ll review how you can use
the IRS 1031 for big tax savings and equity
build up. I’ll explore how the Qualified
Intermediary or QI works, advantages and
disadvantages of the 1031 and how you can
even exchange into a REIT or Real Estate
Investment Trust. And as always—talk to your
tax professional.
Issue Date: ro/sa/