Now that real estate values are on the rise again, there is a lot of talk about ways to minimize the tax when you sell a property that has gone up in value. One of those strategies is something called a like-kind exchange. When you sell, you don’t pay tax on the gain. Instead, you roll over to another property.
In its simplest form, it’s still not simple. You need to sell the property without letting the proceeds touch your hands. You’ll use an Accommodator to hold the funds until you find the property you want to buy. You need to make a list of possible exchange properties within 45 days. And you need to complete the transaction within 180 days from the initial sale. Plus, you need to reinvest all of the proceeds you received and buy a property (or properties) for at least as much as you sold the initial property.
If you do all that, you have created a like kind exchange aka a Section 1031 exchange aka a Starker exchange. You didn’t escape taxes, just postponed them. However, with careful planning “tax later” can become “tax never.”
There are a couple of downsides to a like kind exchange. You have to roll over all of the money and buy a property within a very short window of time. You roll over the basis too, so eventually if you keep doing 1031 exchanges, you start to run out of basis as you depreciate it away.
Still, if you’re good a buying property, holding it for a few years and creating/spotting good appreciation areas, you can build up wealth faster without having to pay tax along the way.
That’s a simple 1031 exchange.
You can also sell multiple properties and exchange into one property. You can sell one property and exchange into multiple properties. You can take property you own with others (with the right titling) and exchange out your portion, while your partners do something else.
And then you can also do a reverse exchange. In this case, you buy a property first (through an Accommodator) who holds it and then you again have 180 days to sell your property. You are still doing the same kind of exchange, with the same rules, but you’re doing it in reverse.
And that long introduction, leads to a question that I received at USTaxAid.com.
“For Reverse 1031 exchange, if we put on the buying contract ‘Seller agrees to participate in 1031 exchange’. sufficient and when do I have to contact an intermediary?
We found a property prior to listing an unoccupied rental and were not sure if we would be able to do exchange but wanted to try and leave option open.”
In a word, the answer is “no.” It isn’t that simple. The Accommodator needs to be involved from the very beginning. And since the Accommodator actually takes title you’re buying, you may have funding issues (How do you get a loan?) and the Accommodator needs to be indemnified against any liability associated with the property. This is especially true if there are tenants or construction occurring on the property. They usually require bonds and insurance that protect them during the time they hold the property.
Does it work? Yes. Make sure, though, that the tax benefits far outweigh the financial and “hassle” cost of doing a reverse 1031.
I strongly urge anyone considering any type of exchange to first talk to experts in the field. There are a lot of ways to go wrong and the law is pretty unforgiving if you stray outside the lines in this case.