The term ‘1031 Exchange’ can be somewhat of an enigma in the real estate industry. It is heard often but not always understood. To answer some frequently asked questions about this frequently used process, I asked Julie Tumbaga, Vice President & Regional Sales Executive of Old Republic Exchange, based in Honolulu for some answers. With over 15 years of experience in the real estate industry, and having overseen Old Republic Exchange’s tax-deferred department since 2001, there is no-one better on the islands to answer.
AF: What is a 1031 exchange?
JT: 1031 Exchange is a way to defer paying capital gains tax with property that is held for investment or for productive use in a business or trade.
AF: How long has it been available?
JT: These rules were issued in the 1991 Treasury Regulations issued by the IRS.
AF: Whats the most common situation that people use a 1031?
JT: First, they use it to defer paying capital gains tax. Secondly, they use it to diversify and leverage their real estate investments
AF: What are some of the common pitfalls that a client should try to avoid during the process?
JT: 45 days can be a really short time frame to find replacement property to identify. So, I suggest people start looking a little early so they are not pressured.
AF: There are a number of key components that a property has to meet when entering into a 1031. What are they?
JT: Your clock starts ticking the day you close on the relinquished property sale. You will have 45 days from that date to identify what you are going to purchase and a 180 days to close on it. The 45 days are included in the 180 days. So, you don’t get 45 and then a fresh 180! You do not have to have an accepted offer when you identify property, however you cannot make any changes to the Identification Notice after your 45th day. You will have to be able to puchase something that is on your list. There are no extensions. Every day counts!
AF: If someone uses a 1031 Exchange, does it mean they no longer owe the tax on the transaction?
JT: This is a deferral of taxes! Not a get away from taxes forever! When they die, their kids would inherit it at a step up in basis. They would not inherit their capital gain burden, but they would have estate taxes to pay.
AF: If someone is wanting to purchase a property in another state from where they are selling their residence are they able to do so?
JT: Anywhere in the U.S. and U.S. Virgin Islands and Guam. Not Puerto Rico!
AF: What are some of the major changes you have seen in the 1031 exchanges over the years and are there any major shifts to be expected soon?
JT: There have not been any major changes, just a few tweaks here and there. There is always proposed legislation on getting rid of 1031’s. As of now there are no written proposals so, we just don’t know.
AF: Finally, Why is it a good tool for someone to consider, and when can they use it?
JT: Well, if they do not want to pay capital gains tax, this is the avenue to take. This is used whenever an investor sells investment property and does not want to pay capital gains tax.