This is a gray area of the law. In theory, it is possible to do a 1031 immediatly. The key here is that you have to show that you intended to hold the property long term as an investment.
Starker Exchange's advise is that the property must be put into service (rented) for at least one year. That means that if you fix it up for 6 months and then rent it for only 6 months they aren't as comfortable with it.
You can do whatever you want but if you get audited, you'll have to convince the IRS guy/gal that when you bought it you really were planning to keep it.
If you do a 1031 you do not have to do another but you'll be taxed on your entire gain from any previous 1031's
Are you saying that if I realize a gain on a property that I do not pay taxes on by purchasing a second property with a 1031, and I subsequently sell the second property with no gain and no 1031 exchange, that I would still be liable for the gain that I received on the first property?
So I guess it begs the question, why defer the tax?
It is different than defering income while you are working until you are retired; in that case you would be hoping to be at a lower tax rate in retirement, and would only pay on the capital that you took out of the retirement account.
However, if you are defering the tax on a 1031, and each successive 1031 realizes more capital gain, it seems to me you could have quite a large amount of capital gain down the road. \
Additionally, the long term capital gain rates could go higher.
Finally, the paper work burden seems excessive, as you could have to maintain records for years and years, almost infinitely.
Missing something - yes. Maybe it is a bit subtle though so...
The benefit of the deferral is you get to reinvent the full value of the prior property. If you sold, paid 25% in taxes (a made up number) and then bought another property you have less to work with.
By moving your tax basis forward you get to continue to get the full impact until you choose to sell. You will pay tax on the gain at some point but the full amount has had a lot longer to compound and grow.
Play around with a calculator and see how the numbers grow in the two cases. It will become more real that way.
Now, depending on your tax planning there may be reasons why the gain taking place in a later year actually costs you less. That has nothing to do with an 1031 exchange.
A second benefit of a 1301 exchange is that your heirs inherit the property at its basis as of the day they inherit it. So they would not pay capital gains on the property and all taxes are avoided provided the value does not excede the minimum limit for inheritance tax.
Their basis is the FMV of the property at the time they inherit it. Their basis has nothing to do with what you paid for the property or anything prior to your death.
If you buy a property today for $100,000 and die several years from now when the property is worth (FMV) $200,000, your heirs could sell it for $200,000 and owe no capital gains taxes. If they hold the property for some time and it appreciates to $250,000 and they sell it they would owe capital gains on the difference in the selling price ($250,000) and their basis ($200,000).
[ Edited by nothanks on Date 09/26/2004 ]
If I sell a property that I purchased using a 1031 exchange, what is the basis for calculating my gain? Is it the second property price minus the sales price of the original property and all other costs? If yes does that mean that I have to hold onto records of all of the properties that I do 1031 on into perpetuity so that I can back calculate basis if I need to at some point in the future?
If you buy property 1 for 100,000 and sell it for 150,000
then buy property 2 for 200,000 and sell it for 250,000
Your total gain would be 50,000 from the first sale plus 50,000 from the second sale for 100,000 total gain subject to capital gains tax.
I believe that rehab costs (if necessary) can be added to your purchase price when establishing your basis but check with your accountant. I'm fairly new and am not positive. If this is true and you invested 25,000 in rehabing property 1 your basis would be 125,000 instead of 100,000 and would result in a total gain of 25,000 (first sale) plus 50,000 (second sale).
The math gets very complicated if you don't reinvest all of the procedes from sale 1 because you would owe capital gains on a relative proportion of the procedes not reinvested. This is when accountants start to earn their money.
This is a gray area of the law. In theory, it is possible to do a 1031 immediatly. The key here is that you have to show that you intended to hold the property long term as an investment.
Starker Exchange's advise is that the property must be put into service (rented) for at least one year. That means that if you fix it up for 6 months and then rent it for only 6 months they aren't as comfortable with it.
You can do whatever you want but if you get audited, you'll have to convince the IRS guy/gal that when you bought it you really were planning to keep it.
If you do a 1031 you do not have to do another but you'll be taxed on your entire gain from any previous 1031's
Are you saying that if I realize a gain on a property that I do not pay taxes on by purchasing a second property with a 1031, and I subsequently sell the second property with no gain and no 1031 exchange, that I would still be liable for the gain that I received on the first property?
You got it. Sorry, but you don't get out of paying taxes by doing a 1031, you just get to defer them.
Roger
Thanks for the info so far,
So I guess it begs the question, why defer the tax?
It is different than defering income while you are working until you are retired; in that case you would be hoping to be at a lower tax rate in retirement, and would only pay on the capital that you took out of the retirement account.
However, if you are defering the tax on a 1031, and each successive 1031 realizes more capital gain, it seems to me you could have quite a large amount of capital gain down the road. \
Additionally, the long term capital gain rates could go higher.
Finally, the paper work burden seems excessive, as you could have to maintain records for years and years, almost infinitely.
Am I missing something?
Missing something - yes. Maybe it is a bit subtle though so...
The benefit of the deferral is you get to reinvent the full value of the prior property. If you sold, paid 25% in taxes (a made up number) and then bought another property you have less to work with.
By moving your tax basis forward you get to continue to get the full impact until you choose to sell. You will pay tax on the gain at some point but the full amount has had a lot longer to compound and grow.
Play around with a calculator and see how the numbers grow in the two cases. It will become more real that way.
Now, depending on your tax planning there may be reasons why the gain taking place in a later year actually costs you less. That has nothing to do with an 1031 exchange.
John
[addsig]
Here is an article that I wrote on the HOLDING Requirement for 1031 Exchange properties: http://comm.thecreativeinvestor.com/modules.php?name=News&file=article&articleid=572&mode=thread&order=1&thold=-1
[addsig]
A second benefit of a 1301 exchange is that your heirs inherit the property at its basis as of the day they inherit it. So they would not pay capital gains on the property and all taxes are avoided provided the value does not excede the minimum limit for inheritance tax.
Hi,
But if my heirs inherit this at the basis , isn't the tax consequence high to them when they go to sell it at market value?
?!?
Their basis is the FMV of the property at the time they inherit it. Their basis has nothing to do with what you paid for the property or anything prior to your death.
If you buy a property today for $100,000 and die several years from now when the property is worth (FMV) $200,000, your heirs could sell it for $200,000 and owe no capital gains taxes. If they hold the property for some time and it appreciates to $250,000 and they sell it they would owe capital gains on the difference in the selling price ($250,000) and their basis ($200,000).
[ Edited by nothanks on Date 09/26/2004 ]
Thanks for that clarification.
Now onto another issue I do not understand.
If I sell a property that I purchased using a 1031 exchange, what is the basis for calculating my gain? Is it the second property price minus the sales price of the original property and all other costs? If yes does that mean that I have to hold onto records of all of the properties that I do 1031 on into perpetuity so that I can back calculate basis if I need to at some point in the future?
Thanks!
If you buy property 1 for 100,000 and sell it for 150,000
then buy property 2 for 200,000 and sell it for 250,000
Your total gain would be 50,000 from the first sale plus 50,000 from the second sale for 100,000 total gain subject to capital gains tax.
I believe that rehab costs (if necessary) can be added to your purchase price when establishing your basis but check with your accountant. I'm fairly new and am not positive. If this is true and you invested 25,000 in rehabing property 1 your basis would be 125,000 instead of 100,000 and would result in a total gain of 25,000 (first sale) plus 50,000 (second sale).
The math gets very complicated if you don't reinvest all of the procedes from sale 1 because you would owe capital gains on a relative proportion of the procedes not reinvested. This is when accountants start to earn their money.