Advertisement
investing

July 15 Is the Magic Date Now for 1031 Exchanges

The IRS is giving real estate investors currently working toward 1031 exchanges a little extra time to get their deals done during the coronavirus pandemic. But there are still some fine points to figure out.

A 1031 exchange is a powerful tax-deferral tool, provided you meet strict IRS deadlines. In response to COVID-19, the IRS has temporarily loosened those deadlines. Here's what a 1031 exchange is and what the IRS’ new moves mean for real estate owners and buyers.

What is a 1031 exchange and how does it work?

Simply stated, a real estate owner swaps one “like-kind” property for another in an IRS-authorized process called a 1031 exchange.

Any real estate owner has the ability to sell a property that has appreciated in value and defer any capital gains taxes. If the entire exchange is completed within the strict 45-day nomination period and the 180-day timeframe as required by the IRS, taxes are deferred.

Advertisement - Article continues below

The catch is, the seller must buy another “like-kind” property, following all guidelines of IRS Code 1031. Like-kind requirements for real estate are broad to include land, houses, apartments, office and retail buildings, warehouses and any other form of real estate held for investment purposes. In other words, an investor could choose to swap an office building for apartments.

Let’s say an investor sells a property and nets a $500,000 profit. If the investor does not exchange, then the total combined exposure for federal and state taxes, plus depreciation recapture could be as much as 30%, depending upon the seller’s basis in the property. But if the investor exchanges, the full $500,000 can be transferred into a replacement property. As the investor continues to exchange properties over time, this equity grows as capital gains taxes continue to defer.

It's all about timing

A 1031 exchange must follow strict deadlines. Under normal conditions, the clock starts ticking when the relinquished property closes. Then, the seller (or “exchanger”) has 45 days to identify qualified replacement properties and 180 days to purchase the replacement property. It's important to note that this “swap” must be completed in 180 days, not 45 days plus 180 days.

Unique challenges for property buyers and sellers during COVID-19

Although it seems like the world has come to a complete standstill, investors are still actively buying and selling real estate, albeit at a reduced number of transactions. My firm is a real estate sponsor and syndicator; you'd be surprised how many investors currently have 1031 exchanges in progress. Many more hope to either sell or “swap” before the close of this tax year.

Real estate investors are facing unique challenges because of COVID-19. Lending requirements are stricter as lenders evaluate the recent drop in income collections and add debt reserve requirements. Site inspections have become nearly impossible, with apartment residents sheltering in place and retail stores and office spaces closed.

Advertisement
Advertisement - Article continues below
Advertisement - Article continues below

For buyers, the challenge now for a 1031 exchange is trying to find a good replacement (or “upleg”) property. Many sellers have pulled their properties off the market waiting for a normalization period — and that’s why some recently announced IRS extensions are so important. A number of deadlines have been pushed that will help investors in exchanges and those looking to buy more property.

The IRS’ new extension: What we know and what we don’t know

The IRS issued a notice on April 9, 2020, providing “additional time to perform certain time-sensitive actions.” This deadline relief is specifically for 1031 exchanges and opportunity zone investments that are currently underway.

For any property owner who initiated a like-kind exchange by selling the old property — and for whom either the 45-day identification deadline or 180-day closing deadline falls between April 1 and July 15 — the deadline has been extended to July 15. For example, an exchangor who originally had a 45-day identification deadline of April 1 now has an extension to July 15 (the requirement to close the sale within 180 days, or mid-August, remains). The extension allowance would not apply to exchangors with original identification or closing deadlines beyond July 15.

The COVID-19 IRS 1031 exchange deadline extension does still have some gray areas, however, as the guidance provided on this issue prompts new questions. For one, there is no guidance to how deadlines after July 15 will be adjusted. Also, investors are still waiting for individual states to go along with federal guidelines. When you exchange, you’re also deferring state taxes. That’s the biggest uncertainty as of now.

1031 exchanges are always a complicated investment strategy, and will be especially so for the 2020 tax year. Sophisticated investors know that having an established team of experienced professionals in place is critical to ensure all of the IRS requirements are satisfied.

About the Author

Karlin Conklin

Principal & Executive Vice President, Investors Management Group

Karlin is Principal and Executive Vice President of Investors Management Group, a privately held real estate firm headquartered in Woodland Hills, Calif. IMG has transacted over $1.6 billion nationally in this cycle, with over $500 million in multifamily assets (3,000 units) currently under management nationwide. She holds an MBA from the University of Oregon.

Advertisement

Most Popular

12 Tax Deadlines for July 15 (It's Not Just the Due Date for Your Tax Return)
tax deadline

12 Tax Deadlines for July 15 (It's Not Just the Due Date for Your Tax Return)

Between due dates for IRA or HSA contributions, paying estimated taxes and other deadlines, there's more to do by July 15 than just filing your federa…
July 10, 2020
65 Best Dividend Stocks You Can Count On
stocks

65 Best Dividend Stocks You Can Count On

These 65 Dividend Aristocrats are an elite group of dividend stocks that have reliably increased their annual payouts every year for at least a quarte…
July 8, 2020
Know Why Your Credit Score Changes: 9 Money Moves to Consider
credit & debt

Know Why Your Credit Score Changes: 9 Money Moves to Consider

Your credit score is a key indicator of your financial well-being and of the risk you pose to lenders. How good is yours?
July 10, 2020

Recommended

Check Your Financial Adviser Now (and Every Year) or Regret It Later
wealth management

Check Your Financial Adviser Now (and Every Year) or Regret It Later

Fewer than 10% of investors use free background checks like Investor.gov, BrokerCheck or IAPD to check their financial advisers’ backgrounds. These on…
June 23, 2020
The Answers to More RMD Questions
retirement

The Answers to More RMD Questions

The CARES Act made 2020 required minimum distributions optional. But what are your next moves?
June 12, 2020
A Little Hedging Can Go a Long Way to Protect Your Retirement Savings
retirement

A Little Hedging Can Go a Long Way to Protect Your Retirement Savings

What sounds like a hedge fund but is nothing like one? A hedged equity portfolio. This type of investment portfolio can help you avoid much of the pai…
June 10, 2020
Pass Along Life Lessons With an Ethical Will
retirement

Pass Along Life Lessons With an Ethical Will

Create a legacy letter to communicate values, experiences and life lessons to your family.
June 9, 2020