When Your 1031 Exchange is in Trouble
There are other Capital Gains Tax Deferral options available to you.
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One of the great government programs in the world of real estate transactions is the 1031 Exchange. This IRS tax deferral option was put into effect in 1921.
The Exchange allows the real estate seller to defer their capital gains tax by exchanging their depreciated property for another like property. As with all the dozen-plus IRS deferral programs, certain requirements must be met. In normal market conditions, the 1031 Exchange regulations require focus and understanding, but the rules are manageable.
When the market conditions are not ‘normal’, reasonable regulations can become problematic. In today’s market, we have an environment that can be challenging. Limited inventory, rapid economic expansion, and seller driven pricing.
Then starting in early 2020, we added the COVID-19 into the economic mix. This pandemic has created an economic overnight shutdown, and rapidly growing unemployment. The first-quarter GDP shrank -4.8%. Expectations are that this number will decline even further with economic revisions.
Many real estate sellers looking to complete a time-sensitive 1031 Exchange can find themselves in a challenging situation. Fortunately, the IRS provides alternative deferral options that can be advantageous in the current market conditions.
One excellent example is the IRS(C) 453(A) Installment Sale with a Tax-Free non-recourse loan. With this deferral program, the seller receives their money at closing, while deferring their capital gains tax for 30 years.
With the 453(A) the seller is then able to buy any property or investment they choose, without the time limits or like property restrictions of the 1031 Exchange.
The key for real estate sellers is to understand that they have options. In a world of uncertainty, a hurried transaction can be costly. This market created by the pandemic will ultimately create significant buying opportunities. Avoid making a rash buying decision because of artificial time restrictions. You have options.
(IRC) 453(A) Installment Sale with Monetization Loan
The correct implementation of IRC 453 allows the asset seller to receive their money in a tax-free loan at closing, while deferring their capital gains tax obligation for 30 years.
Utilize a Qualified Intermediary (QI) the same as a Facilitator in a 1031 Exchange.
Asset Types to be sold: Real Estate, Business, Intellectual Property (patents), Private Stock Sales.
Loan Type: Uncollateralized, limited recourse, 30 years in length. P&I payments come from the QI, not the seller.
Seller Protection: Seller is protected from actions or financial failures of either the QI or Lender.
Use of Loan Proceeds: Seller (Loan Recipient) can invest the proceeds in a fashion they deem appropriate.
Value of a Tax deferral: The financial value comes from the basic ‘Time Value of Money’.
If Seller dies before the end of 30 year deferral: The deferral continues. The beneficiaries pay the tax in 30 years and reap the rewards of the investment.
Example
Assume an asset sale resulting in a $1 million tax debt. Seller could pay the IRS $1 million, or invest the $1 million for 30 years, then pay the tax.
