Even though our world may feel like it is at a standstill, many property owners are still navigating the time-constrained process of a 1031 exchange. However, in response to the chaos of the pandemic, the IRS issued Notice 2020-23, which extended deadlines for time sensitive tax actions.
In the process of any 1031 exchange, there are two discrete deadlines set by the IRS. First, the affected taxpayer has 45 days from the point of sale of the original property to formally identify prospective properties for the exchange. After these properties have been identified, the buyer has 180 days to close on the sale of a new property in order to avoid capital gains tax as a result of the original sale.
In a world not plagued by a pandemic, these deadlines would vary for all buyers. However, Notice 2020-23 makes it so any deadline — both those for the first and second step of the process — that originally fell between April 1st, 2020 and July 15th, 2020 has a blanket extension to July 15th, 2020.
Perhaps the last few weeks have come and gone quicker than you anticipated. If you are frantically trying to complete the required steps for your 1031 exchange before July 15th, rest assured: you are not alone. To streamline the process, we made a checklist of actionable steps that you can complete to avoid paying capital gains taxes on your properties this year. Read on to identify your key steps below.
1. Seek Advice — Estimate The Amount of Taxes You Owe
Before embarking on your 1031 exchange, the best first step is to decide if this is your best course of action. At Realized, our foundation is built around this process, but we also recognize that it may not be ideal for all situations. Before you make any decisions, discuss your situation with a tax advisor to ensure that a 1031 exchange is the best choice for your overall investment goals. Additionally, use our capital gains tax calculator to determine how much you would owe based on the state you reside in, and your own tax and debt basis.
2. Identify — And Write Offers — For Any Replacement Properties You Are Considering
Once you have decided that a 1031 exchange fits your needs, you’ll need to identify a property for your like-kind exchange — before July 15th. There are a few different ways to do this, but the most common method is the “Three Property” rule. This rule allows you, the buyer, to state formal interest in up to three properties — as long as one of the properties is ultimately chosen as the replacement property within the 180-day exchange period. Your Qualified Intermediary, or a third-party agency such as a settler agent, can help you to complete this step in the process.
3. Prepare To Have Some Of These Offers Possibly Not Be Accepted
The pandemic has led us into a seller’s market. As the threat of COVID-19 grew early this year, many sellers took their properties off the market, citing difficulties finding interested parties and showing properties to buyers.
Beyond this, we estimate that roughly 100,000 individuals are attempting to complete a 1031 exchange before the July deadline. This means that the market is buzzing with interest, thus requiring buyers to propose increasingly competitive offers. If you are in the process of identifying your replacement property, a backup plan is critical in the event your first-choice property is snatched off the market as the result of a price war.
4. Find A Lender (If Needed)
A willing source of financing is difficult to come by in this economy. Insecurity in the market could mean possible reluctance from lenders, even those you have a prior relationship with. Reach out to lenders as soon as possible to ensure financing is available for your upcoming purchase.
5. If All Else Fails, Take A Deep Breath — There Are Other Options
You’re working on a time crunch in unprecedented times. If you simply cannot finish these steps by July 15th, consider putting a backup plan in place. Enter: Delaware Statutory Trusts (DSTs). DSTs are portfolios of passive, institutionally managed commercial real estate holdings diversified across property type, geography, and sponsor.
DSTs are a great alternative in the event your primary replacement property falls through, or if you cannot obtain financing. They are readily available and can be a backup plan in the event your direct property transaction isn’t able to close. What’s more, DSTs buy you more time — allowing you to 1031 exchange your funds into a real estate portfolio until you have the time to identify the ideal direct property for you.
In a world where COVID-19 has lenders holding tightly to their purse strings, DSTs are pre-financed, meaning that you won’t need to acquire your own financing for your investment. 1031 exchanges have strict debt and equity requirements, which DSTs can meet without forcing you to secure a loan in your name.
As with any investment, it is wise to ensure that you understand the disadvantages of a DST before you ultimately make your decision. As always, the team at Realized is here to help in any way. If you’re panicked, don’t worry — we can help. Reach out to us today: 877-797-1031.
Full disclosure. The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation. This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.