Are 1031s Good or Bad?
I would call myself 1031 neutral. They have to fit and sometimes we try too hard to make them fit. I see it both ways in going to a larger property or downsizing or selling off a small chunk. Both ways have their strategies and reasons for the transaction. I would like to show you a couple of strategies I have seen work without being forced.
I sat down with a potential client that said, as long as no names were mentioned, I could tell his story. He started small, although, in his mind, he thought it was big. He bought a parcel, saw it appreciate, and rolled it into a bigger more attractive piece using a 1031 exchange. He has done this 4 times over 20 years and has been able to defer over $3.5 million in capital gain taxes. Of course, I said yeah but when you do have to finally pay, OUCH! His answer intrigued me. I will either hold or just keep rolling gains until I die then my kids get the new cost basis and it will be very satisfying on my deathbed knowing I have beat Uncle Sam. His thought process is as long as Uncle Sam keeps printing money that land is a pretty safe place to be, especially, if you are using tax-free dollars the whole way.
The other story was in the opposite direction was but by no means less interesting and yes I have permission to tell you about it. A large landowner had gotten to the point of many farmers and ranchers that age and energy were starting to become an issue. They loved their place and the lifestyle but wanted to travel and not be tied down quite as much. They agreed to sell a portion of their property to lessen the work and become more liquid. Since they sold the biggest portion of their property and had considerable gains, they coincided the 1031 sale with as much capital gain losses from other financial assets so they could offset the capital gain from the 1031 sale. Many people don’t sometimes realize that they can be carry forwarding capital gains losses that they have not been able to use if they have not been able to offset them with gains through the years. And sometimes we need to take potential losses in a certain year to offset gains in that same year. I will give myself an assist on this one since I mentioned they should make an appointment with their accountant to talk through strategy before putting the property on the market. They purchased an income producing property with some of the proceeds and offset the rest with long-term capital gain losses. Dollars were saved and I now have a spot at the dinner table anytime I’m passing through.
1031s are not super painful but timing can be the biggest issue and there are lots of rules. As a seller, you have to identify to the Title Company that this transaction will be a 1031. You have 45 days to identify properties that you are interested in and 180 days to close on the property of choice. The properties have to be like-kind properties and taxes are deferred. This is not just an individual opportunity since most legal entities can do a 1031 exchange. If you think there is a chance of doing a 1031 but your not sure, it will cost you several hundred dollars for the option. If it doesn’t happen it just becomes a taxable transaction like if you had never done a 1031. Beyond that, all the paperwork is handled by the 1031 Exchange agent. There are rules if your new transaction does not cover the full value of the property you sold and all depreciation on the sold property will be recaptured at the time of sale.
There are numerous small technical rules that I did not go into for the fear of putting you to sleep. I strongly encourage the use of CPAs, Tax Attorneys, and 1031 Exchange companies to safeguard that you are following all the rules and understand the technicalities going into the transaction. I also would say having that consultation before the transaction starts is important. Planning in advance saves time and money and relieves a lot of stress!
Disclaimer: Any tax or legal advice contained in this article is not intended or written to be used without consulting your own CPA or Tax Attorney. It is only written for informational use and as an example for discussion.
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About the Author
Partner at Venture West Ranches
Buzz Tatom, a partner at Venture West Ranches, is a ranch owner and has built, run and sold numerous businesses in his career. This gives him a unique background in helping Montana farmers and ranchers navigate the life decisions that we all have to face. Whether it is passing a ranch on to the next generation or planning for eventual sale, his talents and contacts help save clients money Readability Needs improvement and navigate complicated transactions.