How The Recent Tax Changes Affect Your 1031 Exchange

You’ve heard of 1031 real estate exchanges and aren’t sure what they are. Now tax reform has been passed and you wonder if 1031 exchanges are affected. So let’s look at before and after to see if it will help you get a handle on the whole thing.

A 1031 exchange is an exchange of property

How The Recent Tax Changes Affect Your 1031 ExchangeBasically, a 1031 exchange is an exchange of property that falls under Section 1031 of the tax code. Real estate is a big part of this.

Typically, when a person sells a piece of property they will owe taxes on whatever money they realize as a gain. A gain is the difference between what you paid for a piece of property and what you sold it for, less certain allowed deductions. The tax on this is called capital gains. Most people will avoid paying capital gains by taking that money gained on the sale and purchasing another property. That’s the typical scenario.

Sometimes, however, you can trade one property for another and defer the capital gains on the transfer. Deferred isn’t avoiding paying the tax, it’s just putting it off. The property exchange can include just the real estate, or it can include cash, relief from debt and other kinds of property that isn’t real estate. The simplest type of Section 1031 exchange is a simultaneous swap of one property for another. Obviously, they can be much more complex. But this is basically what a 1031 exchange is.

Now that tax relief has been passed by Congress, there are some changes to Section 1031. In fact, the ability to defer capital gains taxes using 1031 exchanges of real property was not changed at all. That’s good news, to a point. That property swap is safe, but swaps that include other types of property are not.

The new tax law repeals 1031 exchanges for all other types of property that are not real property. This means 1031 exchanges of personal property will no longer be permitted beginning this year.

The changes also affect investment property owners and deducting net interest expense

Property owners must elect out of the new interest disallowance tax rules. There is a new interest limit which applies to existing debt. It also continues the current depreciation rules for real estate, which is very important for investment property owners. The only difference is that the depreciation is over a longer period: 40 years for a nonresidential property, 30 years for a residential rental property, and 20 years for qualified interior improvements.

Use a professional for 1031 exchanges

Both before the changes and after, 1031 exchanges are something that you shouldn’t be attempting without the help of a professional who truly understands how the law works and doesn’t. Most Realtors have a good handle on 1031 exchange basics. If it’s something you’re interested in doing, be sure to question prospective Realtors about their experience with these types of property transfers. If it’s something they have done enough to mean that their experience is appropriate for your needs, take the questions to the next step. Ask if they are familiar enough with changes to Section 1031 exchanges under the new tax relief bill.

If you have your heart set on a Realtor not familiar with 1031 exchanges and the tax law effects, consider hiring an attorney who specializes in real estate or tax law. The last thing you want to have happen is you trade homes thinking you are saving on taxes now, only to find you did it wrong and have to pay a huge capital gains tax that you can’t afford. As we all know, the IRS will not hesitate to put a lien on that traded house you now own if you can’t pony up the tax bill.

Don’t take a chance with your finances and home. Do your homework, ask lots of questions and be careful.