A special thanks to Tracey Wilson at Investment Property Exchange Services, Inc. for providing this information. Visit her website for additional information or to get in touch with her and her team.
Late Thursday evening, 4/9/20, the IRS issued Notice 2020-23, extending 1031 deadlines (it also included other extensions, such as the tax filing date is moved out to July 15th).
- The Notice is a little confusing, because it is not written like the typical Disaster Relief Notices, which in the past extended the 45-Day ID and/or the 180-Day Exchange deadlines by 120 days each.
- Instead, this Notice extends any 45-day ID deadline or 180-day Exchange deadline that occurs between April 1 and July 14, out to July 15, 2020.
- So the “extension window” is only 106 days: 4/1/20 to and including 7/14/20. So, again, if the Exchanger’s 45-Day ID deadline falls in this window, the deadline gets moved out to July 15th. If the Exchanger’s 180-Day deadline falls in this window, it gets extended out to July 15th.
- We are working with other real estate professionals to convince the IRS to change the start date from April 1st to January 20th so that the extensions apply to more taxpayers.
- Here are two examples to illustrate the current extension.
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- Example 1: Exchange began April 1, 2020. 45th day is May 16, which would be extended to July 15, 2020. Taxpayer must still close on replacement property by Sept 28, which is the 180th day; because Sept 28 is after the last day of the disaster period (July 15).
- Example 2: Exchange began Dec 31, 2019, 45th day is Feb 14, 2020. ID period is not extended because it is before April 1. The 180th day is June 28, which would be extended to July 15, 2020.
- This is link to IPX’s IRS Notice for 1031 Extensions:https://www.ipx1031.com/covid19_1031_extensions/
- The sale of any real investment property is subject to capital gains recognition – which is about a30% blended or effective capital gains tax:
- 15% &/or 20% on the appreciation (both tax rates may be applied in phases, depending on the amount of the gain and the taxpayer’s AGI)
- + 25% unrecaptured depreciation (referred to as §1250 gain, unless it’s raw land; whereas accelerated depreciation is recaptured at ordinary income rates under §1245)
- + 3.8% ACA tax (Medicare surtax or Net Investment Income Tax, under §1411) above certain income thresholds
- + 4.63% State of Colorado
- Total, blended, or effective capital gains rate in most cases is about 30% (and up to 40% for high tax states)
- But all of these taxes may be deferred under a properly structured 1031 exchange
- To defer all of the gain, and thus defer the taxes, the client needs to do three things:
- Purchase replacement property (it’s possible to buy multiple properties) in total that isequal or greater in value, and
- Reinvest all of the equity into the replacement property, and
- Obtain the same or greater debt on the replacement property – but debt may be replaced with additional cash, but cash equity cannot be replaced with additional debt.
- It is possible for the seller to do a partial exchange, either buying down in value and/or keeping some of their cash/equity, and paying the taxes on only that amount (called “boot”).
- Although they are called Like-Kind Exchanges, “like-kind” is actually very broadly applied: any real property (used for business or held for investment) can be sold and exchanged for any other real property (including, oil & gas, water rights, minerals leases, etc.) anywhere in the U.S.
- Client can exchange into Vacation or Second Home types of property, and have some limited personal use and enjoyment of this property.
- Lastly, if the exchanger wants, they can eventually move into the acquired replacement property (assuming it is residential in nature), and treat it as their personal primary residence – and later if/when the client sells it, some of their gain is tax free up to certain limits (fractional amount of the limits under Section 121 of $250K/single and $500K/married).