John Mccarthy, a real estate investor based in California, had bought an investment property worth $400K five years ago. He has now invested $575K in the property that includes $125K profit. How can John sell his property without recognizing any capital gains tax?
He would do a 1031 Exchange.
John’s transaction could be possible only when he sells all profits he wishes to recognize, and invests the total amount in another like-kind real estate within 180 days using a 1031 exchange. So, what should John do first?
Sell his property and identify another within 45 days.
When doing a 1031 exchange, the first thing IRS requires an investor to do is come up with an identification of the new property within 45 days from the sale of their relinquished property. Therefore, John must sell his real estate and send written identification of the potential replacement property to his QI within 45 days. The replacement property must be equal or greater in value than the relinquished property.
Now all John needs to do is relax and wait for the closing day. That’s when his QI will deposit the funds to the attorney, and acquire the replacement property. Wait, what about capital gains tax? Well, John had already deferred the taxes by reinvesting the entire proceeds from the sale of his relinquished property into another like-kind property. Now, he has a new asset without any tax liabilities.
What if you fail to identify replacement property?
There are good chances that you might not be able to identify a replacement property before the deadline. What should you do then? It will be better if you prepare yourself in advance. Start looking for prepackaged investments like DSTs or TICs. They also work as 1031 replacement properties. A 1031 exchange program lets you defer capital gain taxes if you reinvest your sale proceeds into a DST and buy its shares. Similarly, you co-own a real estate in a TIC along with other investors. TIC exchange properties can be found on a few websites of the companies that facilitate 1031 exchanges.
What should you do in this lockdown situation?
We recommend you speak to your advisor first. Since we are in a complete lockdown stage, the chances of locating a property are very thin. So, we suggest you go with either a DST or a TIC investment to close your 1031 exchange. Let us know where you stand in your 1031 exchange. Haven’t planned yet? Into the 45-day identification period? Or have no clue at all? We will get all that covered for you.