On April 9, 2020, the IRS issued an extension for time-sensitive transactions within April 1 to July 15 to all be moved to July 15 due to the COVID-19 pandemic. With different businesses and industries at a standstill, this is a welcome gesture that allows different individuals and organizations to prepare for the future while keeping up with their losses due to certain markets functioning at limited operations.
Another benefit of the IRS’ extension is the extended opportunity for property owners to have a moved deadline for 1031 exchanges. A 1031 exchange is when a real-estate owner swaps their property for another that has similar qualities through the IRS’s authorized procedure. This investment strategy is an effective way to hold on to properties while hoping for the perfect chance to buy-out with a greater margin for profit.
“What is a 1031 exchange?”
Any registered real estate owner can sell their property that has been appreciated while deferring any capital gains taxes. To push through with the process, however, agencies require the real estate owner to find a ‘like-kind’ property. This applies to a wide variety of properties, ranging from land, houses, retail buildings, and apartments as long as they are in the form of real estate held for investment purposes.
An investor can choose to swap a building that they own with a ‘like-kind’ property depending on the property’s net profit. If the exchange is successful within a strict 45-day nomination period together with a 180-day timeframe required by the IRS, the property’s taxes will be deferred.
“Why do people perform property exchanges?”
If an investor sells a property with a net of $800,00 profit, they are then asked if they want the option of exchanging their property. Depreciation recapture, with the combined exposure of state and federal taxes, can reach up to a 30% cut from the net profit if the investor decides to push through with the sale.
On the other hand, if an investor exchanges their property, the full $800,000 can be transferred to a valuable replacement property. Swapping properties over time then increases the equity of exchange as capital gains taxes will continue to defer.
“How do I make a 1031 exchange?”
A 1031 exchange follows strict deadlines, which require investors to be fast if they’re looking to make a profit without being disallowed for exchanging properties. A seller is tasked with 45 days to find a replacement property to bid, with a leeway of 180 days to consider the full purchase of the replacement property. At the same time, be aware that the 45 days is contained within the 180-duration of full payment to the newly bought real estate, not an additional 180 days to the former 45-day window.
“What are 1031 exchanges like during the COVID-19 pandemic?”
Although the world’s economy is recovering amid the COVID-19 pandemic, many investors are still actively buying and selling real estate properties. However, with the presence of the global healthcare issue, lending requirements have become stricter to evaluate the drop in income collections due to the varying durations of lockdowns in different industries.
Site inspections have also become impossible to perform due to retails stores being closed, while office spaces remain closed as per quarantine protocols. The challenge to potential investors who are looking to try their hand at 1031 exchanges is to find a viable replacement property while other properties are still unavailable in the market.
Many sellers are looking for the right timing to sell once a normalization period is announced. I believe the best way to strive to make the most profit out of a 1031 exchange is to look at developing market trends while keeping a close eye on promising properties that could soon open for sale once the market is ready again for exchanges.
At PJL Investments, we guide our clients through the process of a 1031 exchange by making sure that they perform the right financial choices in exchanging properties. Get in touch with our 1031 exchange advisors now!