One of the great tax deferral options in the world of real estate sales is the 1031 Exchange.
The 1031 Exchange allows the real estate seller to defer their capital gains tax, by exchanging their property for another like property. As with all the many IRS tax deferral programs, certain requirements must be met.
However, real estate sellers looking to complete a time-sensitive 1031 Exchange, have sometimes found themselves in a challenging situation. They may be running out of time, unable to negotiate a reasonable financial transaction or other issues associated with real estate transactions.
If a seller is concerned that their 1031 Exchange could face problems, they could always choose to utilize another tax deferral option. One excellent example is IRS(C) 453(A) Installment Sale with a monetization feature.
With this tax deferral program, the seller receives their money at closing in a tax-free form, while deferring their capital gains tax for 30 years. The challenge is that the 1031 exchange and the 453(A) Installment Sale are two different tax-deferral options. Each having its own rules and regulations.
However, if you work with an experienced ‘Exchange Facilitator / Designated Intermediary’ you can build a safety net by using both deferrals in the same transaction. In addition to protecting against a failing 1031 exchange, there are other financial reasons where the seller can benefit from utilizing both a 1031 Exchange and a 453(A) Installment in the same transaction.
When would Combining IRC 1031 Exchange & IRC 453(A) Installment Sale?
- When you fear that your 1031 Exchange might not work out as planned.
- In cases where a replacement property covered only a portion of your sales proceeds.
- In cases where you want a new property but also needed cash for other uses.
Examples of combining tax deferral options:
Seller receives $5,000,000. taxable dollars from their sale and begins the 1031 exchange.
- Seller finds a desirable replacement property for $3,500,000 utilizes the 1031 exchange. The seller is then unable to find an appropriate property for the remaining $1,500,000. Using an experienced exchange facilitator, the seller then defers the remaining $1,500,000. Using a 453(A). The seller receives the remaining funds in a tax-free form and defers the tax for 30 years. The seller can now use the $1,500,000. to buy any property they desire with none of the 1031 exchange restrictions.
- The seller is interested in using some of the $5,000,000. of the sold property to exchange for another property. However, the seller also needs $2,000,000. in cash, to pay for other debts and alternative investment opportunities. The seller starts with the 1031 exchange process. They find an appropriate replacement property for $3,000,000. and utilize the 1031 exchange. Using an experienced exchange facilitator, they then transfer the remaining $2,00,000. to a 453(A). The seller receives this money in a tax-free form, defers the tax for 30 years, and invests the money as needed.
What are the important keys in utilizing two options for one sales transaction?
- You always start with the implementation of a 1031 Exchange.
- You need to utilize an exchange facilitator who has experience with both 1031 & 453.
- The minimum dollars necessary for the 453(A) implementation is $500,000.
- Utilize a coordinator who is experienced implementing a 453(A) Tax Deferral.
Contributed by Jack Gruber