Guest post by Katina Farrell, Certified Divorce Real Estate Expert and Realtor, Homes By Katina at MetroBrokers
Due to the rise in home values, when it comes time to sell your property, you may face hefty tax consequences and want to roll your capital gains from one property into another one.
Lately, I’ve heard people say they’re “just going to just do a 1031 exchange” as a tax-savings approach. A 1031 exchange provides an exception to paying these taxes at the time of sale if you reinvest the proceeds in a similar property as part of a qualifying exchange.
It’s important to note what it takes to qualify for a 1031 exchange, as well as how to ensure that if you qualify you don’t exempt yourself because of a mishandling of the funds or miss timelines you didn’t know about.
Below are basic things to know when you consider pursuing a 1031 exchange. If you are interested in doing so, it is critical that you consult with a qualified tax professional — especially in a divorce proceeding, which makes these transactions even more complicated.
Basic Rules of 1031 Exchanges
- Only pertains to investment properties.
- Does not apply to primary residences or vacation homes unless they can qualify as an investment under a small sliver of exceptions.
- Property must be exchanged for a “like for like” property, which means another investment property must be purchased, not a primary residence (again, a few exceptions apply).
The 1031 Exchange Process
- Identify a replacement property within 45 days of selling the relinquished property, in writing.
- Sale must be complete on the replacement property within 180 days after the sale of the relinquished property is completed or the due date of the income tax return.
- The funds from the relinquished property cannot be touched by the principal. A qualified intermediary or exchange facilitator must handle the exchange of funds.
- Title: The replacement property must be purchased in the same taxable entity. So if a couple holds joint title to their rental property and choose to do a 1031 exchange, they must purchase the new rental property together.
- However, 1041 of the IRS code pertains to tax-free transfers from one spouse to the other. Although not ideal, this could be a round-about way to accomplish a tax savings. You should work with an experienced tax professional to guide you through this.
- If one party wishes to move into their rental property after the divorce, there are a few things to keep in mind:
- If that property was acquired as a 1031 exchange, there are rules that to comply with.
- If you did not acquire their rental property as a 1031, you should consider the tax consequences of converting the characterization of that property from a rental to an owner-occupied, especially if you plan to sell it in the future.
You can refer to the IRS Fact Sheet for 1031 Exchanges for more information. You should also work with a qualified real estate professional who understands the intricacies of these transactions to ensure you are in compliance with timelines and guidelines.
Katina Farrell is a certified Divorce Real Estate Expert based in Englewood. She has been a full-time Realtor for over 20 years. Contact her at 303-324-1172 or online for a free consultation.