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1031 Exchanges & Capital Gains Tax

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Last Updated on June 28, 2022 by lindseymahoney

On episode 21 of From the Nest Podcast, Chris and I are reviewing 1031 exchanges and capital gains tax with our listeners. We are by NO means experts, but we have learned a lot about both of these subjects these past few years and want to share our knowledge with our friends!

1031 exchanges & capital gains tax

Capital Gains Tax

Capital gains tax is a levy assessed on the positive difference between the sale price of the asset and its original purchase price. Long-term capital gains tax is a levy on the profits from the sale of assets held for more than a year. The rates are 0%, 15%, or 20%, depending on your tax bracket. Short-term capital gains tax applies to assets held for a year or less, and is taxed as ordinary income.

  • Capital gains tax is only paid on realized gains after the asset is sold
  • Capital gains treatment only applies to “capital assets” such as stocks, bonds, jewelry, coin collections, and real estate property
  • The IRS taxes all capital gains but has different tax approaches for long-term gains vs. short-term gains
  • Taxpayers can use strategies to offset capital gains with capital losses in order to lower their capital gains taxes

1031 Exchange

This strategy allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long another “like-kind property” is purchased with the profit gained by the sale of the first property.

7 Rules to Qualify for the 1031 Exchange:

  • Investment property for investment property – cannot exchange it for personal property
  • Also cannot use 1031 for vacation properties unless it was a full time rental
  • You can also use multiple properties – for example, if you sell 3 rental properties, you can invest into one bigger rental properties with all 3
  • You cannot use 1031 for personal property (residences and vacation homes – unless the vacation home is a rental property)
  • The net market value and equity in the home must be of equal or greater value with your new investment
  • Ex: You have a rental property with a value of $100K and have a $50K mortgage – the new property (properties) must equal more than $100K value and $50K equity into the properties total
  • Any boot received is taxable to the extent of gain realized on the exchange. In other words, you can carry out a partial 1031 exchange, in which the new property is of lesser value, but this will not be 100% tax free.
  • Ex: If you exchange the $100K value property for $75K property, you will have to pay capital gains tax on the “boot” of $25K profit made
  • 1031 must have the same taxpayer name. However, an exception to this rule occurs in the case of a single member limited liability company (“smllc”), which is considered a pass-through to the member.
  • Ex: If I own a rental property in my name, I can exchange it for a property that is held by my LLC
  • The property owner has 45 calendar days, post-closing of the first property, to identify up to three potential properties of like-kind
  • It’s necessary that the replacement property be received and the exchange completed no later than 180 days after the sale of the exchanged property OR the due date of the income tax return (with extensions) for the tax year in which the relinquished property was sold, whichever is earlier.

Disclaimer: We are knowledgable but not experts in this area! We recommend you work with an accountant to understand all details surrounding 1031 exchanges to see if it is right for you.


Show Notes

This Week…
  • We are continuing to work on our rental property – Balky – and are really hoping to get plumbing in place this week.
  • I went on a lovely vacation to Banff for the Bachelorette party of my soon-to-be sister-in-law! (HUMBLE BRAG WARNING)
Lake Moraine - So much inspiration in this breathtaking place!
Lake Moraine – So much inspiration in this breathtaking place!
Hanging out with the bride-to-be in Banff, Canada.
Hanging with the bride to be in Banff

Tips of the Week…

Chris: When considering financing for your personal property renovations, Home Depot and Lowe’s have great CC options with 0% interest for a certain period of time and AMEX also has good options for financing home renovations. If you want to invest in a fix and flip but don’t have the funds, check out Ground Floor – this site introduces you to hard money lenders and is a great option to finance your flip!

Lindsey: An inexpensive option for kitchen backsplash is tin ceiling squares. This is easy to install, easy to clean and affordable.

Thanks so much for listening! If you are feeling generous, please leave us a review on iTunes!