In a hot real estate market, one of the most common questions that clients ask us is: “why should I do a 1031 Exchange when property prices are high?” Basically, why would you buy in the same appreciated market that you just sold in?
This past Friday 1/15/2016, a 70-year old caller phoned into The Dave Ramsey Show from California. Most of his retirement money was invested in rental properties. The caller’s long term gain rolling into the 1031 Exchange was about $2,000,000. His question to Dave Ramsey was… how can I find a ‘deal’ in just 45-days?
As a reminder, in a normal or “forward” exchange, you have two simultaneous clocks ticking once you sell your relinquished property:
Timeline #1 – 45 days to identify up to 3 properties (up to 6 using the rule of 200)
Timeline #2 – 180 days to close on 1 or more of the 3 properties that were identified
Dave’s response to the caller was: your tradeoff is that you’re either going to pay your tax rate on the Capital Gain or you are going to pay more for the property due to a shortened timeline. Dave said that he, “loves the 1031 Tax Deferred Exchange; its a brilliant way to keep the government’s hands off of your money.” Dave said while you might not get the best deal, because you don’t have a lot of time to look for a bargain, you can’t overlook the benefits of the 1031 Exchange. Either way you’re going to “give up some money.”
In this case, the sound advice is to move forward with the tax deferred exchange as it enables you to reinvest your money and you maintain rental income on your full equity from the relinquished property sale. If you were to pay the capital gain, your equity is diminished immediately which inhibits the return you would make on your next investment. In addition to Dave’s answer, you would also have to pay a Depreciation Recapture which further reduces your equity after the sale.
Be sure to consult a good CPA and potentially a tax attorney when looking into tax deferred exchanges and the sale of real estate.
For more information about 1031 Exchange rules, please be sure to visit the IRS website – https://www.irs.gov/uac/Like-Kind-Exchanges-Under-IRC-Code-Section-1031
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~Kyle Malnati
Madison & Company Properties
1221 South Clarkson Street, #400, Denver, CO 80210