Successful completion of a like-kind exchange is an extremely rules-based endeavor, which, in most cases, will require the assistance of both a CPA and an independent intermediary to achieve the desired outcome. Think of it less like a traditional sale and more like swapping one investment for another. This lets you roll the full value of your original property into a new one, keeping your capital intact and working for you. The 1031 or “like-kind” exchange can be a major tax savings for real estate investors.
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Learn more about passive activity limitations, like-kind exchanges, involuntary conversions, and Sec. 1237. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Working Out a 1031 Exchange of Real Estate
Under the American Families Plan, when the 3.8% net investment income tax is added to the proposed maximum long-term capital gains rate, high-income earners would pay as much as 43.4% on long-term capital gains. Although the details of the proposed changes are still taking shape as of this writing, increased taxes are expected on both earned and capital income. Instead, if you sell the asset using a 1031 exchange, you can defer capital gains taxes and reinvest the entire $700,000. Since those taxes are merely delayed, not erased, it’s important to the IRS to track the transaction for the current sale and the later disposition of the replacement property. Taxpayers should retain copies of Form 8824, settlement statements, purchase and sale agreements, and any correspondence with a qualified intermediary. These documents verify that the exchange was structured correctly and that all deadlines were met.
How to Keep the Books: Accounting for 1031 Exchanges
You’ll likely have to execute a “deferred” exchange, in which you engage a qualified intermediary (QI) for assistance. Planning your exchange meticulously helps you track aspects of your 1031 exchange, such as capital gains, investment property values, depreciation, etc. By obeying IRS guidelines, you can avoid costly mistakes and prevent any IRS audits. As such, it’s best to independently evaluate your properties to determine their fair market value and avoid any discrepancies.
How to Report a 1031 Exchange on Your Tax Return
Consequently, she defers all gain recognition and depreciation recapture, saving $378,870 of income tax in the current year, which can be used for reinvestment purposes. A qualified intermediary (QI) is the recordkeeper for a 1031 exchange. The QI maintains all relevant documents related to the exchange, including the identified replacement properties.
- Learn how to accurately report a 1031 exchange on your tax return, including key filing details, basis adjustments, and documentation requirements.
- Detailed documentation of these transactions is critical to ensure compliance with IRS requirements and substantiate adjustments during audits.
- By diligently recording this information, you ensure the IRS knows the capital gains deferred through your 1031 exchange.
- Remember that time is of the essence in executing a successful tax-deferred swap.
- Hypothetical example(s) are for illustrative purposes only and are not intended to represent the past or future performance of any specific investment.
For exchanges involving complex transactions, you should consider working with our Certified Public Accountant (CPA) at Universal Pacific 1031 Exchange. We provide personalized accounting guidance to ensure that your exchange complies with IRS requirements. Other bookkeeping options involve using DIY spreadsheet tools such as Microsoft Excel or Google Sheets. With these spreadsheets, you can create custom templates for tracking 1031 exchange transactions, depreciation, and capital gains or losses.
Realized
- That figure ties into the form 8848 (? the 1031 exchange form), so does the $6,000.
- In addition, you will owe any depreciation recapture taxes you have also deferred.
- Mistakes or omissions could lead to audits or unexpected tax liabilities.
- You can also use accounting software to ensure there’s accuracy in your transaction records.
So, for example, you deferred $40,000 of capital gains taxes on the first exchange. If you complete another one and again have taxes due, that amount is added to the earlier $40,000. If you eventually dispose of the final replacement asset in a traditional sale, you will owe the accumulated taxes. In addition, you will owe any depreciation recapture taxes you have also deferred. Mortgage boot occurs when the investor’s debt burden decreases in the exchange. If the debt on the replacement property is less than the debt that 1031 exchange accounting entries was paid off on the relinquished property, the difference is considered mortgage boot received by the investor.
What Happens to the Deferred Taxes?
Sometimes an investor starts an exchange in one calendar year but is unable to acquire the replacement property and the exchange fails the following calendar year. Instead of selling, paying taxes, and then reinvesting the leftovers, you can “exchange” that property for a new one. Your entire gain gets rolled directly into the next deal, tax-deferred.
Both the relinquished and replacement properties must meet the like-kind standard, meaning they must be of the same nature or character, even if they differ in quality. While most real estate qualifies, exceptions exist, such as property held primarily for sale, which does not meet the criteria under Treasury regulations. A reverse 1031 exchange is when the taxpayer gets the replacement property beforeselling the relinquished property. Under the reverse 1031 exchange safe harbor, the taxpayer “parks” the replacement property with a third-party until the relinquished property is sold. Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments are often sold by prospectus that discloses all risks, fees, and expenses.
Failure to meet these deadlines disqualifies the transaction from tax deferral, resulting in full recognition of gains. Additionally, liabilities transferred during the exchange, such as mortgages, can affect the recognized gain. For instance, if an investor relinquishes a property with a $200,000 mortgage and acquires one with a $150,000 mortgage, the $50,000 difference is treated as boot and becomes taxable.