NUTS & BOLTS
1031 EXCHANGE
ment, the taxpayer may only use the property for 14 days or 10 percent of the days rented to others, whichever is less, per year. However, days spent by the taxpayer at the property perform- ing maintenance and repairs do not count against days used by the taxpayer. Is everybody laughing? If you treat your home as an investment under these criteria, and on your tax return, then you may also 1031 exchange the property upon sale. NO. 5 REAL ESTATE MUST BE SIMILAR IN USE TO BE CONSIDERED LIKE-KIND UNDER A 1031 EXCHANGE. The statute says that both properties must be “held for invest- ment or used in trade or business.” This is known as the quali- fied-use test. If state law defines the property interest as real estate, then the IRS will also treat it as real estate. Law school teaches that real estate is a “bundle of rights.” The rights can be unbundled and owned separately. This creates the ability to 1031 exchange from one real estate interest to a very different real estate interest. You may only 1031 exchange real estate located in the United States for other real estate located in the United States.
NO. 6 I MUST TRADE EQUAL OR UP IN DEBT TO FULLY DEFER INCOME TAX IN A 1031 EXCHANGE. Not technically true. See discussion under Item 1 above. NO. 7 IF I TAKE CASH OUT OF A 1031 SALE, THEN I CANNOT 1031 EXCHANGE THE REMAINDER. Taking cash out of the 1031 sale is perfectly OK. You pay tax on the full amount of the cash taken out, but the balance of the money can be 1031 exchanged. Moreover, because borrowed money is not income and because equity is a moving target, it is possible to take tax-free cash out of a transaction with a cash-out refi of either the relinquished or replacement property. Please feel free to contact us for greater detail on these rules. •
Steven Hickox has been a licensed attorney in Colorado since 1981. He is the co-owner, founder and president of 1031x.com. In business since 1994, 1031x.com has handled more than $1 billion in 1031 Exchanges. Contact him at Steve1031x@gmail.com or 888-899-1031.
Misconceptions Unmasked 1031 EXCHANGE IS NOT EXACTLY A NEW CONCEPT, BUT MISUNDERSTANDINGS REMAIN. HERE ARE SEVEN MYTHS REFUTED.
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by Steven Hickox
D
espite the fact that 1031 exchanges have been around since the 1920s, a lot of false beliefs about them re- main. Here are seven misconceptions, corrected. NO. 1 TO QUALIFY FOR A FULLY TAX-DEFERRED 1031 EXCHANGE, I ONLY NEED TO REINVEST THE CASH THAT I RECEIVE AT MY SALE. The general rule is that, in order to defer all income taxes in a 1031 exchange, you must trade for a property that is equal or greater in value and in equity. Of course, if you have no mort- gage on the relinquished property, then equal or up in value and in equity are the same thing. The downside to this rule is that it is hard to use a 1031 exchange when you are trying to deleverage. But then most real estate investors use leverage to their advantage, and they do not consider this a “downside.” NO. 2 TAX BASIS RESETS TO THE PURCHASE PRICE OF THE REPLACEMENT PROPERTY IN A 1031 EXCHANGE. Not true. The simplest way to estimate your basis in the replacement property is this shorthand formula: Take the tax
basis of the relinquished property, and add to it the amount by which the replacement property exceeds the relinquished property in value. The sum is your new basis. NO. 3 WHEN I CONVERT AN INVESTMENT PROPER- TY TO A PRINCIPAL RESIDENCE AND LIVE IN IT FOR TWO YEARS, I CAN THEN SELL THE PROPERTY IN A FULLY TAX-EXEMPT SALE UNDER IRC SECTION 121. You may convert a 1031 exchange replacement property to your principal residence two years after purchase, and the IRS will not disallow the 1031 exchange. If you then live in the property for an additional two years prior to sale, then you can use IRC Section 121 to exempt the allowable limits of that code section ($250,000 single, $500,000 married). But no matter how long you own and occupy the property, you will always have to pay tax on the recaptured depreciation. NO. 4 VACATION HOMES ARE HELD FOR INVESTMENT AND ARE THEREFORE ELIGIBLE FOR A 1031 EXCHANGE. For a vacation home to qualify for investment tax treat-
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