Above: Ken Tharp, president of Iowa Equity Exchange, navigates the sometimes tricky landscape of 1031 Exchanges.
BY STEVE DINNEN
While 1031 exchanges underwent a major overhaul in 2017, they remain a great way to defer taxes when properly followed. And therein lies a rub, as their sought-after tax break goes away unless you adhere to rules that may be tricky to navigate and are unforgiving of error.
IPX1031, the nation’s largest qualified intermediary for 1031 exchanges, estimates that at least 45 percent of all real estate investment transactions involve an exchange. So billions of dollars of deals are involved every year.
Or maybe just millions, at the local, singular level. Say you have a qualifying piece of real estate worth $2 million you wish to sell. You paid $400,000 for it way back when, so you’re facing a hefty capital gains tax. But you can stall off on paying that tax if you deploy a 1031 and buy a replacement property worth $2 million.
In addition to investment real estate, this also works easily for farmland, says Ken Tharp, president of Iowa Equity Exchange. Farm owners may have acquired their property decades ago, and thus have a very low cost basis that will have to be reckoned with when they sell their property outside of an exchange.
A big hurdle with a 1031 exchange is finding replacement property, especially on short notice, says Tharp, who serves as a qualified intermediary to process these deals. “It’s not easy to find suitable property in a shortened time.”
Your initial sale starts a clock. You have 45 days from the sale of your property to identify replacement properties (typically a maximum of three). Then you have 135 more days to finalize a deal on any or all of these properties.
You’ll use an attorney, accountant or people who work specifically on locating exchange properties to find a replacement piece of real estate. But by law they cannot serve as your mandatory exchange intermediary. That would be the bailiwick of Tharp, www.iowaequityexchange.com, who is in charge of money that goes into these deals. He finds a bank to hold funds, and serves as both the seller of the initial property and buyer of the replacement property.
There are variations on this theme, such as a reverse 1031 where you buy your new property before selling the first one.
And while 1031s are typically considered efforts to avoid current taxes, they also might help for future situations. You can, for instance, place an acquired property into a revocable living trust with children named as beneficiaries. Upon your death, the property transfers to the beneficiaries, free of taxes with a stepped-up basis.
See? Sometimes you can cheat the tax man.