In this article, we are going to answer your questions about 1031 Exchange
– What is a 1031 exchange?
– 1031 exchange how much to reinvest?
– What number of days do you have to use a 1031 exchange
– How does a 1031 exchange affect the buyer?
– Does the 1031 exchange work?
– How to do 1031 exchange?
– Can 1031 exchange be used for a primary residence?
– Who handles 1031 exchange?
A step by step guide of how to use a 1031 Exchange
1 – Start the sales process of selling a real estate property
2 – Work out if there are ways of mitigating FIRPTA without the need for a 1031 exchange if this is a risk
3 – Use a 1031 exchange through a Qualified Intermediary
4 – Reinvest the money in a new investment property to mitigate both FIRPTA and CGT
5 – Consider the UK Capital Gains Tax implications of selling a US-based real estate if UK resident
Before we go any further, we need to know the benefits of a 1031. Why would anyone want to use such documents…
Foreign Investment in Real Property Tax Act of 1980 (FIRPTA)
We have written another article that deals with the 15% Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) that is applied to foreigners that sell US real estate property investments.
As a quick recap, a seller of a real estate property investment gets $300,000 from the sale. A 15% FIRPTA tax charge is applied to the sale, meaning that they have 20 days to pay the IRS $45,000. This means that the seller of the property leaves with just $265,000.
And then there is…
Capital Gains Tax when selling a real estate property in the US.
We have written another article on the subject of Capital Gains Tax when selling US-based real estate property. You will typically pay a tax on the gain that you have made on the sale of your real estate property investment. The tax liability form the capital gains will be paid on 15th April when you submit a 1040 tax return to the IRS.
FIRPTA and CGT
It is possible that you have paid $90,000 for the 15% FIPTA but have a $50,000 Capital Gains tax liability. You would then reclaim the overpaid tax on your 1040 tax return.
It may be advisable to put in your tax return soon after 1st January so that you can claim the overpaid taxes sooner rather than later.
I very much doubt, but it is possible that you have paid $90,000 FIRPTA but have a tax liability on the capital gains of $100,000. In these instances, you would need to pay the IRS the $10,000 difference when submitting your 1040 tax return to the IRS.
When can you use a 1031 exchange to mitigate Capital Gains Tax and FIRPTA?
The seller may use the proceeds of the sale to purchase replacement real estate property investment. Please note the word is “investment” The buyer should not use this FIRPTA if:
– The property sold is a home
– A replacement real estate property is a home
– The replacement real estate property is not in the US
– Replacement assets is not lower than the gross sales price of the sold real estate property investment.
A 1031 exchange means that the money you obtained from the sale is reinvested. Not only does this mean that FIRPTA may be avoided but so to is Capital Gains Tax
1031 exchange mitigate the need to pay FIRPTA and Capital Gains Tax on the sale of real estate property
Like for like exchanges to avoid FIRPTA and Capital Gains Tax
It is possible to sell a real estate property investment and use the proceeds to reinvest in a new real estate property investment. This is what is known as like for life provided:
– The sold property is a property investment
– The purchased property is a property investment
– The amount of money reinvested into the new property is the same or more (cannot be less, even by $1)
– Neither property may be classed as stock (to be flipped)
How many days do you have to use a 1031 exchange?
You only have 45 days from the point of sale to identify a replacement asset to purchase. There must be an agreement to buy the replacement real estate property investment and documents are with a qualified intermediary.
In addition to the 45-day rule mentioned above the property in question must be completed within 180 days of the original sale date.
What can void the 1031 exchange?
The seller of the real; estate property wishing to use the 1031 exchange cannot take control or have access to the money involved in the sale. The said 1031 would become invalid of the seller of the real estate property obtains or controls the money received in the sales transaction.
Will FIRPTA and Capital Gains Tax still become payable if not all monies are reinvested?
The seller of the real estate property may wish to reinvest a proportion of the amount received. The 1031 FIRPTA and Capital Gains Tax will also be reduced but only by the amount reinvested.
From the above, we had a sale $300,000 that had a taxable capital gain of $100,000. The Capital Gains deferred would be 66.67% if you reinvest $200,000 of the $300,000. You would then have to pay tax on the 33.33% of the $100,000 capital gains.
The money that is not reinvested and subject to tax is often referred to as “Boot“.
The state tax on Capital Gains Tax
Please note that we have only discussed the federal tax associated with the capital gain. You may have to pay state tax too.
Do you have an ITIN?
In order for you to submit a 1040 tax return to the IRS, you will need to obtain an Individual Tax Identification Number (ITIN). You can obtain an ITIN number by completing a W7 form, which with some ID may be taken to the IRS.
Within a few months, you will then be provided with an ITIN number. Couples need to be made aware that each person that needs to submit a tax return will require their very own ITIN.
Other useful articles that you may be interested in
Now that you have read this article be sure to read more about
A special note for those that need to submit a UK tax return to HMRC
Not only do you need to think about US tax payments to the IRS, you also need to consider whether or not you have to pay tax in the UK too.
You may need to pay tax based on Capital Gains Tax to HMRC in the UK. This is because the 1031 exchange tax deferral is not allowed int he UK. Any tax saved in the US is saved. The savings are not possible in the UK. You are likely to have a UK tax liability when selling US real estate property investments to HMRC despite you using a 1031 exchange.
A 1031 exchange is ideal for British people that are UK non-resident for tax purposes.
You can read more about foreign capital gains tax on Optimise Accountants website, whom that focus on helping real estate investors save tax in the UK.