Answers to frequently asked questions about 1031 Exchanges
By: Barbara S. Potts, RB & L. Lee Potts, RB
Aloha Group Maui, KW Island Living
1. What is a 1031 exchange?
a. The Internal Revenue Code allows you to sell real property and defer payment of capital gains tax if you use the proceeds to acquire a “like kind” property.
b. The code also provides that the gain is not recognized if property held for investment or productive use in a trade or business is exchanged for property held for investment or productive use in a trade or business.
2. What are the advantages of doing a 1031 exchange?
a. Defer your capital gains tax – federal rates for long term capital gains are 15-20%+, Hawaii tax rate for long term capital gains is 7.25%.
b. You can replace a non-performing property or relocate your investment into one or more properties in a different market that better meet your goals.
3. What is the long-term advantage if you continue to defer gains through 1031 exchanges?
a. You can defer taxes and liquidate when you are in a lower tax bracket.
b. Your heirs can inherit property on a stepped-up basis and pay no capital gains taxes upon your demise.
c. You can eventually move into a property, own it for 5 years, live in it for at least 2 years, and then claim the homeowner gains exclusion.
4. What is a like kind property?
a. Any real estate held for investment or productive use in a trade or business
b. Exclusions include personal property, leasehold property with less than 30 remaining years on the lease, and property outside the US or US territories (not including Puerto Rico)
5. Can you exchange into a lower priced property and take out some of the cash?
a. Yes - you would pay capital gains on the cash, or “boot” taken out of the transaction, but could still defer some of the gain.
6. Is it a good time to do a 1031 exchange?
a. Yes, if you have a significant amount of equity and want to upgrade or increase your portfolio or relocate an asset.
b. You can still take advantage of historically low interest rates and lock in a rate on a new property at a low rate before further increases.
c. You can strategically plan your goals now to help your family with real estate and create a financial plan to leave a legacy.
d. You can restart the depreciation clock on a fully depreciated property.
7. What is the best way to plan an exchange?
a. Work with an expert to identify your long-term goals and investment strategy.
b. Begin searching for a replacement property at the same time you prepare the property you plan to relinquish for sale.
c. Locate 3 replacement properties before your sale contract opens escrow.
d. Seek advice from a knowledgeable REALTOR, CPA, financial planner, attorney.
Did you know that a 1031 Exchange allows you to defer taxes on the sale of an investment property when you purchase another investment property? You can exchange (sell and buy) almost any real property for another real property. A common misconception is that an exchange has to be a house for a house, a condo for condo and so forth. That’s not the case. It could be a condo for a home, land for a condo, two condos for a commercial property, or other type of exchange for fee simple real estate.
Deferring your capital gains lets you keep your money if you re-invest in another property (or properties) of equal or greater value.
You may, for example, decide to sell a property that is not performing well and replace it with a more productive property. Some of our clients have decided to sell a Maui property for something closer to home on the mainland. Some of our clients have sold mainland properties to make their Maui dream come true.
We bought a 3 bedroom house in Reno that our son lived in while in college and rented the other bedrooms to pay the mortgage. When he graduated we sold that house using a 1031 exchange and leveraged it into two condos on Maui.
The 1031 Exchange can be a great planning tool to build wealth for yourself and your family and create your legacy. You can use strategic replacement properties to diversify your holdings and pass wealth to your heirs. Planning ahead means your heirs could inherit a property with a stepped up basis that could further reduce any capital gains and possibly be in locations that might better suit their future needs.
Property owners will need to work with tax advisors and a Qualified Intermediary in addition to a professional realtor to accomplish the exchange process.
Aloha Group Maui offers free seminars in Maui to inform the public about 1031 Exchanges and other wealth building opportunities in real estate.
Aloha Group Maui is a part of KW Island Living, the Keller Williams Maui franchise. We can help you buy or sell a home or condo - for you to live in full time, part time or as an investment. Learn more about Maui Real Estate in our Maui Real Estate 101 resources section. Stay informed of market trends by reading the Maui Real Estate Advisor. We are your Maui Real Estate Professionals.