By now you’ve probably become an expert in 1031 exchanges, well at least we’re sure we have in all the researching and consulting we’ve done with experts in the topic. While you might think you know everything there is to know about 1031 exchanges, we’re here to give you the low-down about 1031 exchanges and unfortunately some of the pitfalls that come along with them.
So before you decide to jump in and rollover your gains from your current property to your exchange property, read up on these three 1031 exchange pitfalls that we’ve put together with some help from Realized 1031, Firstrade, the balance, and the NY Tax Attorney.
1. Rules, Rules, and More Rules
We’ve mentioned this before, but one important thing to remember about conducting a 1031 exchange is that there are rules and these rules are very strict. Some of these rules consist of the rigid time-frames in which you must identify a new property and sell your existing property (45-Day Identification Period and 180-Day Exchange Period), within these rules are even more rules. Like the rule that states that the replacement property being exchanged according to Realized 1031, “must have a purchased price and mortgage balance equal to or greater than the relinquished property sold.” If this rule and a number of other rules are not met, consequences and penalties are inflicted.
2. Tax Deferred, Not Tax Free
The term “tax deferred” can be confusing to some; what you must remember is that a 1031 exchange is tax deferred, not tax free, the two are not the same. According to Firstrade, “something that is tax deferred is something that must eventually have taxes paid on it. Something that is tax-free will not need any tax payments made.” A tax deferment is simply the postponement of the payment of taxes on capital gains, which according to the balance, paying taxes on capital gains can be deferred almost indefinitely.
With the awesome perk of tax deferment, comes the unfortunate reality of the deferment of losses. This means that any losses acquired in the purchase of your replacement property are not recognized and instead are deferred, their recognition would only then take place when that same property is sold later down the road, according to NY Tax Attorney’s article titled “Gain, Loss, and Depreciation Issues in Like Kind Exchange.” What does this look like exactly? Imagine selling your current property for $ 1 million and then making the exchange over to a like-kind property valued at $500,000, this loss of $500,000 is not recognized and thus, deferred. Instead of purchasing a replace property at the same value as your previous property, you’ve exchanged for a property that is valued less, thus taking a loss.
Want to learn more about 1031 Exchanges? Stay tuned, we’ll be blogging more about 1031 Exchanges in the days to come.
Read all the articles in our 1031 Exchange series here: https://www.mynoi.com/category/1031-exchange/