Fundamental to a 1031 exchange is the requirement that the replacement property be held as an investment property; not as a second home. The property can be converted to a second home, but only after it is first held as an investment. Often loan and deed of trust documents reflect a second home rider clause stating the property cannot be rented out or placed in a rental pool. Caution, beware, “Houston we have a problem” or at least discuss with your financial advisor. Continue reading to recognize whether your Deed of Trust contains a Second Home Rider typically found at the end of the loan agreement.
Tags: Investment Property
As a general rule, when a taxpayer sells real property and realizes a gain on the property, the taxpayer is required to pay capital gains taxes on the gain realized. Although the rate at which capital gains are taxed fluctuates, it is typically enough to warrant looking for legal mechanisms to avoid the obligation. One mechanism used by many taxpayers is a Section 1031 Exchange. Named after the IRS section from which it stems, a Section 1031 contemplates an “exchange” of property instead of an outright sale. When a transaction qualifies for a Section 1031 Exchange, capital gains taxes on the realized gain are deferred. Can the sale of a vacation property qualify for Section 1031 treatment? If certain conditions are met, the answer is “yes."
Typically twice a month, I speak at Commercial and Residential Realtor luncheons or monthly meetings about the benefits for Realtors and their clients of 1031 tax deferred exchanges. I often discover that just as I was, many are unfamiliar with or have a vague idea about 1031 exchanges.
Investment property can be defined as real, tangible and intangible personal property. The common denominator of the three is the intent to generate a return, taxes, limited personal use and eligible for a 1031 exchange. Taxes triggered upon sale are federal and state (if applicable) and recaptured depreciation.
Considering swapping real or personal property held as an investment or for use in a business with another? What are the tax consequences? Is it possible? Yes, though the probability of locating a property with the seller wanting your property is not high.
So if the land or investment property was located and a swap was agreed to, what are the tax consequences? After all, it is important to understand all the transaction expenses. If there is appreciation or the asset is sold for more than it was purchased, a federal and often times a state capital gains tax is triggered. If the asset was depreciated, 25% of the amount depreciated on your taxes is recaptured. These taxes can represent up to 40% of the sale. In a 1031 exchange the tax payment is deferred as long as the replacement property is equal to or greater than the property sold and replaced within a 180 calendar days of the initial sale.
How will the current legislation to maintain the Bush era capital gains tax impact the number of 1031 exchanges and investment property? As a fiscal conservative, I believe over the next two years real property held for investment will continue to stagnate or show little appreciation with the exception of those geographies with job growth translating into demand for housing.