 1031 Exchanges & Shore Property: The Impact of the Tax Reform
By Margo McDonnell, President of the 1031 CORP.
As we deal with snow and bitter cold temperatures, it is hard not to daydream about having the warm sand between our toes and basking in the glorious sun at the Jersey Shore again. Perhaps dreaming about owning property at the Shore can become a reality with careful planning and a little help from section 1031.
Internal Revenue Code Section 1031 allows you to defer gain on the “exchange” of real property held for business use or investment. It is not actually a two-party swap. It is simply the sale of one property followed by the purchase of another within 180 days and linked together by the required paperwork.
After years of concern regarding how 1031 exchanges would be impacted by tax reform, the Tax Cuts and Jobs Act, signed into law on December 22, 2017, spelled it out for us. Section 1031 was preserved as is for real property (real estate) exchanges and repealed for tangible and intangible personal property (such as furniture, fixtures, equipment, vehicle fleets, franchise agreements, etc.). The preservation of 1031 exchanges for real property was welcome news for real estate investors and business owners who understand the benefits of Section 1031. Exchanges allow real estate investors to grow their real estate portfolio using pre-tax dollars and help accomplish many short and long-term investment objectives. Unfortunately, for those selling or buying rental Shore property in a 1031 exchange, the repeal of personal property changes the way real estate exchanges have traditionally been structured.
Prior to January 1, 2018, when selling a Shore rental property which usually contained furniture and fixtures, the personal property could also be exchanged for other personal property of equal or greater value without creating a taxable event for the seller. Under current tax law, the furniture and fixtures included in the sale were likely depreciated and upon sale, must be recaptured at ordinary income tax rates which can be as high as 37%. No longer can you use 1031 exchange funds towards the acquisition of personal property included in the purchase of a 1031 replacement property. Instead, buyers now have the opportunity to immediately expense the personal property which means they can take 100% depreciation in the year of acquisition on new and “new to you” or used personal property. 100% immediate expensing is allowed through the end of 2022 but is then set to start phasing out over the next five years.
While personal property exchanges are no longer available to Shore real estate investors, real estate exchanges provide a number of ways a 1031 exchange can be beneficial:
Trading Up your Current Shore Property
Typically, the closer the rental property is to the water, the higher the rent it commands. If you have owned a rental property at the Shore for a while, with interest rates still low and inventory on the rise, now may be the time to trade up for something that will be a better long-term investment.
Acquiring your First Shore Property
If you own rental property, perhaps in Philadelphia or Haddonfield, but have always wanted to own property at the Shore, why not consider if now is the time to exchange your current property for a rental at the Shore. It may not be the beach front property you always wanted but it is definitely one step closer.
Exchanging one Vacation Home for Another
Until 2008, you were not permitted to exchange one vacation home for another. However, Revenue Procedure 2008-16 opened the window and provided a “safe harbor” for the exchange of vacation homes. While most vacation homes don’t automatically qualify, with planning, any vacation home can. To satisfy the requirements, in the two twelve-month periods prior to the sale of the old property and following the acquisition of the new one, you can only use the vacation home for personal use the greater of 14 days or 10% the number of days it was rented. During those same periods, you must also rent the property to an unrelated party for at least 14 days. These are not easy requirements but the benefits of making it work can be huge.
Planning for Retirement or that Fabulous Vacation Home
A 1031 exchange allows you to acquire a rental property that will eventually be converted into your family vacation home or your year-round retirement home. Revenue Procedure 2008-16 provides a safe-harbor that lets you convert your property from investment to personal use after two years.
Exit Strategy
While I would rather be at the Shore in any weather, if for whatever reason, you have decided that a Shore property is not right for you anymore, a 1031 exchange can help you exchange it for another investment property anywhere in the United States.
Some of the requirements of a successful exchange include:
- You must identify replacement property within 45 days of the sale of the old property and acquire it within 180 days.
- A Qualified Intermediary (QI) is required to facilitate the exchange, hold your sale proceeds and coordinate all the details.
- To maximize the tax-deferral, you must acquire property of equal or greater value and equity.
- The exchange must be in place prior to the sale of the old property.
A 1031 exchange can open an endless number of opportunities at the Shore and now just might be the right time to make them a reality.
CONTACT:
Hugh Merkle to discuss what you want to purchase or sell to do a IRS 1031 Tax-Deferred Exchange @ 609-602-0300 or Email: Hugh@HughMerkle.com.
Margo McDonnell, President of 1031 CORP to discuss the process @ 800-828-1031 and Email: Margo@1031CORP.com
|
