What is a 1031 Exchange specifically relating to the state of Florida?
Section 1031 of the US Internal Revenue Code, also known as, A 1031 Exchange Florida, allows a real estate investor to defer payment of Capital Gains Tax when the profit from the sale is reinvested in a like-kind property of greater or equal value. To understand more about 1031 Exchanges you also need to know more about FIRPTA.
The frequently asked questions about Foreign Investment in Real Property Tax Act (FIRPTA)
As property accountants, we are regularly asked about Capital Gains Tax when selling a real estate property in Florida. We will look to answer the below questions in this Article.
“Are you paying too much FIRPTA and Capital Gains Tax?”
“What are the basics of FIRPTA and Capital Gains Tax in Florida?”
“How does a 1031 Exchange work in Florida?”
“What qualifies as a 1031 Exchange?”
“How long do I have to do a 1031 Exchange in Florida?”
“Is there a time limit on buying a property using a 1031 Exchange?”
“How much does a 1031 Exchange cost in Florida?”
“When can I not do a 1031 Exchange?”
“How can I avoid paying Capital Gains Tax?”
“Can I do a 1031 Exchange on my primary residence?”
“How can I avoid paying FIRPTA?”
“How does this affect our UK readers?”
Are you paying too much FIRPTA and Capital Gains Tax?
As US/UK ex-pat tax experts, we know that legislation and tax law for FIRPTA and Capital Gains Tax can overwhelm property investors.
Many US states have different property legislation and different taxation rates.
This can mean that property investors do not take full advantage of the tax allowances available.
There are many reasons why British people living in the United States pay far more tax than they need.
This is because:
-They do not know what they do not know.
-They have not spoken to a tax specialist that knows all the UK and US tax laws.
-Their accountants in the UK are not knowledgeable about the US tax laws under the IRS.
-Their CPAs are not knowledgeable when it comes to the UK tax laws under HMRC.
What are the basics of FIRPTA and Capital Gains Tax in Florida?
As UK/US ex-pat tax experts, we know that the Florida real estate market is one of the most popular and profitable states for property investment in the US.
Many factors benefit property investors in Florida, such as good prices, low mortgage rates, state incentives to invest, high economic growth, the overall investment outlook and a unique lifestyle.
It is important to understand the basics of FIRPTA and Capital Gains Tax in Florida when investing in property to ensure that the maximum tax-efficiency advantages have been fully utilised.
Basics of FIRPTA and Capital Gains Tax in Florida – History and now
FIRPTA is the Federal law governing the taxation and withholding by foreign investors selling real estate in the US.
Before 1980, a foreign seller was not taxed on the gains realised from the sale of property in the US.
The FIRPTA withholding requirements came into effect after December 31 1984, as a tool to ensure payment to the Treasury Department when a foreign seller conveys real estate in the US.
Under FIRPTA, the buyer is required to withhold 15% of the gross sales price from proceeds as a ‘deposit’ due to the IRS within 20 days of closing the sale when purchasing from a foreign seller. Certain exceptions apply.
Basics of FIRPTA and Capital Gains Tax in Florida – who it affects?
A foreign person is a non-resident alien, foreign corporation, foreign partnership, foreign trust or foreign estate.
It does not include a resident alien if that resident pays income tax in the US on their worldwide income.
FIRPTA can also affect a US citizen if they were an ex-pat before selling their US property.
If the seller is not considered a foreign person, there is no FIRPTA withholding. The seller needs to sign an affidavit stating that the seller is not a foreign person.
A foreign seller must provide proof of FIRTPA compliance when they originally purchased the property.
Basics of FIRPTA and Capital Gains Tax in Florida – Filing
In addition to the requirements under FIRPTA, a foreign person must file a US tax return.
Foreign sellers and the real estate agents for foreign sellers must prepare for FIRPTA before listing the property for sale.
In addition, buyers need to be aware of FIRPTA if the seller is a foreign person.
Everything you need to know about FIRPTA has been prepared for you in one article by our tax team.
If you are British and moving to the US, our YouTube clip will outline important facts about US tax.
How does a 1031 Exchange work in Florida?
A 1031 Exchange allows a Florida real estate investor to defer payment of Capital Gains Tax. CGT would normally be charged upon the sale of a property when the profit from the sale is reinvested in a like-kind property of equal or greater value.
The complexity of the 1031 Exchange process in Florida can sometimes be the main reason why it lacks popularity among property investors.
By using a 1031 Exchange, an investor can effectively swap one of their investment properties for another.
This means you can sell one property and use the proceeds to buy another one without having to pay any Capital Gains Tax on the sale.
The 1031 Exchange process in Florida has three stages.
How does a 1031 Exchange work in Florida? – Stage 1
Stage 1 – Find a qualified intermediary.
Under Section 1031, you cannot access the money you gain from selling a property you own to execute a 1031 Exchange.
A qualified intermediary takes temporary possession of the proceeds from the sale while you purchase your new investment property.
How does a 1031 Exchange work in Florida? – Stage 2
Stage 2 – Identify a like-kind property
The IRS allows 45 days to find a like-kind property from the day you complete the sale of your original property.
When you execute a 1031 Exchange, you can choose up to three different properties without having to be concerned about a limit on value.
How does a 1031 Exchange work in Florida? – Stage 3
Stage 3 – Closing on the replacement property
This is the most complex part of the 1031 Exchange process in Florida, as once you begin the process, you are allowed 180 days to close on the replacement property.
This may sound like a long time, but six months in property investment can elapse quickly and if a property sale falls through, the 1031 Exchange becomes invalid.
This is why it is critical to work with property and tax experts to utilise 1031 Exchange benefits successfully.
What qualifies as a 1031 Exchange?
A 1031 Exchange is a swap of one investment property for another, which defers Capital Gains Tax payment but can only be made with like-kind properties and IRS rules limit use with vacation properties.
Like-kind exchanges are classed as when you exchange property used for business or held as an investment solely for other business or investment property that is the same type or ‘like-kind.
Specific steps to qualify as a 1031 Exchange?
These are the specific steps property investors must follow to qualify for a 1031 Exchange:
- Real estate must be used for investment or business purposes
- The replacement property must be identified within 45 days and purchased within 180 days
- If the value of the replacement property is less, the difference is taxable
- 1031 Exchanges can be used if there is a mortgage on the property
- Accrued deferred Capital Gains tax can be eliminated when property passes on to heirs
1031 Exchanges are like having an interest-free loan from the IRS.
Instead of paying tax on capital gains, property investors can put the money to work immediately and enjoy higher rental income while growing their property portfolio more quickly.
These are the five different types of 1031 Exchanges commonly used by Florida property investors:
Delayed exchange: with one property being sold and a replacement property purchased during the allowed time frame.
Delayed/simultaneous exchange: with the replacement property purchased at the same time as the current property is sold.
Delayed reverse exchange: with the replacement property purchased before the current property is sold.
Delayed build-to-suit exchange: with the current property replaced with a new property.
Delayed/simultaneous build-to-suit exchange: with the built-to-suit property purchased before the current property is sold.
Whichever exchange is used, the proceeds from the sale of a property are held in escrow by a 1031 Exchange intermediary while the replacement property is being identified and purchased.
To ensure that you qualify for a 1031 Exchange, speak to our US property tax team today.
How long do I have to do a 1031 Exchange in Florida?
You have 180 days from the sale of your current property closes to close on your replacement property.
The IRS only allows 45 days to identify potential replacement properties that you wish to purchase.
Using a 1031 Exchange requires planning.
If you need professional help with a 1031 Exchange in Florida, speak to one of our specialists today.
Is there a time limit on buying a property using a 1031 Exchange?
This usually implies a minimum of two years’ ownership.
To gain the full benefit of a 1031 Exchange, your replacement property must be of equal or greater value.
How much does a 1031 Exchange cost in Florida?
You can expect to pay a fee of around $1,000 for a standard 1031 Exchange in Florida.
When can I ignore the 1031 Exchange?
The two most common situations ineligible for a 1031 Exchange are selling a primary residence and property flipping. Both are excluded for the same reason.
To be eligible for a 1031 Exchange, the sold property must have been held for a business or investment purpose.
How can I avoid paying Capital Gains Tax?
A 1031 Exchange allows you to defer Capital Gains Tax on investment properties you sell as long as you reinvest 100% of the sale proceeds into another investment property.
A 1031 Exchange allows property investors in Florida to build wealth faster by keeping money working instead of being paid to the IRS.
Other ways you can avoid paying Capital Gains Tax include:
- Make use of the Capital Gains Tax allowance
- Make use of allowable losses
- Transfer assets to spouse or civil partner
- Invest in an ISA
- Contribute to a pension fund
- Give shares to a registered charity
- Invest in an EIS
To find out everything you need to know about Capital Gains Tax, our detailed Article in the link is essential reading.
Can I do a 1031 Exchange on my primary residence?
A 1031 Exchange only involves investment properties.
Your primary residence is not eligible for a 1031 Exchange. Even a second home that you live in some of the time is ineligible if you don’t treat it as an investment property for tax purposes.
How can I avoid paying FIRPTA?
The most common way to avoid paying FIRPTA is through a withholding certificate.
If FIRPTA withholding exceeds the maximum tax liability realised on the sale of a property, sellers in Florida can appeal to the IRS for a lower withholding amount.
No withholding is required under FIRPTA if the sale price is $300,000 or less, or if the buyer signs an affidavit stating they intend to use the property for personal purposes for at least 50% of the time the property is occupied for each of the first 12-month periods immediately after closing the sale.
It is vital to fully understand the IRS rules on FIRPTA before proceeding with a property investment sale.
How does this affect our UK readers?
Care must be taken to ensure that they do not pay too much capital gains tax to the IRS and the HMRC.
There is a tax treaty between the US and UK. This means that you will benefit from a tax credit in the United Kingdom for any tax paid to the IRS.
To learn more, make sure you head over to our sister company, Optimise Accountants that helps Americans save tax in the UK.
It is one thing to be tax-efficient in the UK or the US; it is another thing to be tax-efficient across the Atlantic.
This is why you need to get a tax advisor that truly understands international tax.