Answers to frequently asked questions about 1031 Exchanges

1. What is a 1031 exchange?

• 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.
• 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 advantages of doing a 1031 exchange?

• Defer your capital gains tax - federal rates for long term capital gains are 15-20%+, Hawaii tax rate for long term capital gain is 7.25%.
• You can replace a non-performing property or relocated 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 exchange?

• You can defer taxes and liquidate when you are in a lower tax bracket.
• Your heirs can inherit property on a stepped-up basis and pay no capital gains taxes upon your demise.
• You can eventually move into a property, own if 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?

• Any real estate held for investment or productive use in a trade or business.
• 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?

• 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?

• Yes, if you have significant amount of equity and want to upgrade or increase your portfolio or relocate an asset.
• 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.
• You can strategically play your goals now to help your family with real estate and create a financial plan to leave a legacy.
• You can restart the depreciation clock on a fully depreciated property.

7. What is the best way to plan an exchange?

• Work with an expert to identify your long-term goals and investment strategy.
• Begin searching for a replacement property at the same time you prepare the property you plan to relinquish for sale.
• Locate 3 replacement properties before your sale contract opens escrow.
• Seek advice from a knowledgable REALTOR, CPA, financial planner, attorney.

Published in Neighbors of West Maui magazine - May 2018