This Example of a South Florida Transaction Illustrates How 1031 Works to Create Generational Wealth
The Scenario – Two Properties are Sold – One New Property is Purchased.
A very bright client of ours purchased two different properties many years ago.
These two properties were in a developing area of Miami-Dade County. Additionally, both of these lots had neighboring properties that were raw acreage.
Both properties are now within a few blocks of a major shopping center, so they have increased considerably in value. Our client plans to continue investing and use the IRS Section 1031 Exchange Rules to defer taxes to leverage her gains toward additional commercial property investments.
She transacts two different Section 1031 exchanges. One for the $2.8 million to purchaser # 1 on lot # 1. The other property is transacted for $2.1 million to purchaser # 2 on Lot 2. She has now done two different Relinquished Property 1031 transactions. Together she has sold properties totaling $4.9 million.
In this scenario, our client used the proceeds from both of her sales (1031 transactions totaling $4.9 million) to purchase one Replacement Property for $4.7 million, leaving her with a surplus of $200,000.
1031 Exchange Basic Rules That Apply In This Scenario
Here are three important rules that apply in this case. For a full overview of 1031 Exchange rules and critical timelines, visit this page from Affiliated1031.com.
Property Value
You must purchase a property of equal or greater value to the property sold or pay tax on the difference.
Exchange Values
You must use all of the cash proceeds from the sale of your Relinquished Property toward the purchase of Replacement Property or pay tax on the difference.
If you offer seller financing on your Relinquished Property, you may be subject to tax as the principal is repaid.
Qualified Intermediary
To qualify for safe harbor tax deferral, sale proceeds must be held by a Qualified Intermediary between the sale of the Relinquished Property and the purchase of the Replacement Property.
Here’s how the client deferred $900,000 in taxes.
The client completed two separate 1031 transactions, and Affiliated 1031, LLC as her Qualified Intermediary, received approximately $4.9 million into its Trust Account. BUT, she only obtained $4.7 million of Replacement Property.
For this example, let’s assume she had no costs on the sale and that she had originally paid $400,000.00 total for both Relinquished (sold) properties. That means that on paper, she had a $4.5 million total profit ($4.9 million less $400,000 = $4.5 million).
The 1031 Exchange rules state that the taxpayer must purchase Replacement Property of equal value or more if they want to defer all of their profit. In this case, she was $200,000 short on the purchase (Replacement) side of the 1031 transactions as she only purchased $4.7 Million worth of Replacement Property.
She must pay the long-term capital gains tax on the $200,000.00. As the lots she owned were undeveloped, there was no depreciation recapture tax, so there was nothing to depreciate. The tax on $200,000.00 will be $40,000.00.
BUT, because she did her two Section 1031 Tax Deferred Exchanges, she has deferred $900,000.00 in taxes, which she used/leveraged towards the replacement properties.
Pretty good result!
Also note that the Exchanger can combine two or more exchanges and purchase one Replacement Property, as long as all of the timelines (45-day rule and 180-day rule) are complied with.
You can view the critical timeline requirements here at the Affiliated 1031 Exchange website.
At Affiliated 1031, we always recommend that the taxpayer consults with their tax and/or legal counsel on all matters dealing with the Internal Revenue Service.
Are you ready to get started with a 1031 Exchange? Call us today at 877.873.1031. Have 1031 questions? Submit your 1031 questions here, and we’ll reply ASAP.
AFFILIATED 1031, LLC.
Ricky Guerrero, Esq., CEO, rg@affiliated1031.com
Steven E. Gurian, Esq., LL.M, President, sg@affiliated1031.com
Se habla español
