Safe Harbour Helps Real Estate Investors With 1031 Exchanges 2/5/19 02/05/19 10:30:03 AM
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Safe Harbour Helps Real Estate Investors With 1031 Exchanges
By Scott Stewart
The Daily Record
The earning power behind a 401(k) comes from compounding the value of returns while deferring taxes as the account grows its balance.
A 1031 exchange, referring to a different section of the Internal Revenue Code, offers
similar tax-deferring advantages
for real estate investors looking to dispose of a property while reinvesting those gains into a new piece of real estate.
Such exchanges can be done for one-time transactions – like swapping developable farmland for acreages elsewhere or trading an office building for a new location – or as part of a strategy real estate investors could use regularly as they manage their portfolio.
While a true exchange involves trading one property for another, the IRS allows the proceeds of one property to fund the acquisition of another, so a typical exchange involves four parties: the owner of the original property, a buyer, a seller and an intermediary.
Jennifer Strand, manager of Safe Harbour Exchange, said a qualified intermediary assists by completing 1031 exchanges by holding money in escrow as one property is sold and another property is purchased.
She said a properly executed exchange shifts the tax basis from the original property to the new one, so any gains realized on the original property are attached to the new property when it’s sold.
“It doesn’t go away, but you defer the tax,” Strand said. “You’ll eventually pay a capital gains tax if you sell the new property.”
The IRS requires carefully following a procedure for executing a 1031 exchange, including ensuring that the cash proceeds from the sale of the original real estate is properly rolled over into the purchase of a new property. Money can only be held in escrow for a short period of time before being reinvested.
“The biggest rule is the taxpayer can’t ever touch the money,” Strand said. “It has to go to what’s called a qualified intermediary, and they hold the money until you find the property that you’re going to purchase.
“That’s where we come into play.”
Attorneys and certified public accountants cannot serve as a qualified intermediary if they’re an agent of a taxpayer, Strand said. Safe Harbour Exchange helps ensure clients meet 1031 exchange requirements, offering independent and expert advice on successfully following the rules.
A 1031 exchange can be used for rental residential real estate, agricultural land, commercial properties and industrial sites. It can be used by corporations or individual investors, but the same taxpaying entity has to acquire the replacement property.
“This is for investment property,” Strand said. “You can’t do this with your primary residence.”
Safe Harbour Exchange is affiliated with Nebraska Title Co., where Strand also serves as president and general counsel after spending 20 years in private practice as an attorney. The companies are separate, but both are subsidiaries of TM Holdings of Topeka, Kansas. Nebraska Title Co. has offices in Omaha, Lincoln, Papillion, Plattsmouth, Auburn, Beatrice, Crete, David City, Fairbury, Kearney and Scottsbluff.
Strand regularly presents an hour-long introduction to 1031 exchanges for attorneys and real estate agents. She said real estate attorneys need to be aware of the pros and cons of 1031 exchanges as well as the rules to assure the exchange is handled correctly.
“Opportunities to speak have given me the opportunity to build my expertise,” Strand said. “If you represent real estate developers, then you probably need to be familiar with 1031 exchanges.”
Those considering a 1031 exchange should talk to their tax adviser, Strand said. There are situations where the tax advantages wouldn’t outweigh the costs or would be minimal.
While not exactly controversial, 1031 exchanges are regularly reviewed by lawmakers looking to simplify the federal tax code. The Tax Cuts and Jobs Act of 2018 eliminated personal property from the rules that govern exchanges. Advocates say that being able to reinvest gains promotes economic development and keeps real estate prices lower because the seller doesn’t have the ability to defer capital gains taxes.
“It is something that is regularly discussed in Congress,” Strand said. “It does facilitate a lot of transactions in development, because if you have that much gain if you sell your property, you may not be willing to sell it. So having the ability to defer the gain and reinvest actually promotes development.”