SPEED ROUND: 1031 Exchanges

Dark Horse CPA

Everything you need to know about 1031 Exchanges in 5-ish minutes. Dark Horse CPA, John Warner, joins Chase for a speed round on the insider tax info that every successful real estate investor knows.

Podcast Transcript

welcome. You’re tuned into taxes, made simple for a speed round on 10 31 exchanges. My  name is chase Berkey, CEO of dark horse CPAs. And I’m joined by the very first CPA to take  the leap of faith into dark horses accelerator program, where he’s built a book of business in  under two years, that is approaching 500 K. 

His name is John Warner and he is a gentleman and a scholar. Well, uh,  gentlemen, well just getting John, is it true that you had to convince your wife a dark horse  was an actual CPA for him before she let you accept the job? Uh, you know, chase, it is true.  When I traveled out to San Diego, I was supposed to be continually updating her on my  location. 

Uh, she had the movie hostel in the back of her head. And if you haven’t seen it,  I’ll tell you it does not end well. Um, you know, you never know when you meet people  through the internet, right. But I can tell you, after over a year and a half at dark horse, CPS,  yay. I’m about 95% convinced that it’s a real CPA firm. 

Well, that percentage sounds about right. So, uh, today this is a rapid fire round.  As the name speed round implies everyone, including our listeners needs a cup of coffee for  knowledge absorption on this one. So, John, please tell me you’re not drinking a cup of folds,  no full juice here. I’m actually drinking a local brew. 

This is a park Avenue coffee there. Costa Rica blend. Pretty good stuff. Beautiful.  Well, today’s episode is on 10 31 exchanges. If you own rental properties or are considering  buying properties with today’s ridiculously low interest rates, you’ve probably heard of a 10  31 exchange, but what exactly is it? 

And why would you do one? All right, let’s start the clock for five minutes. So,  John, what is a 10 31 exchange the chase, the tenant 31 exchange as a transaction where  you exchange one rental property for another, hence the word exchange, even though  you’re actually selling the property to a normal buyer and buying a property from an  unrelated seller, it’s called a 10 31 exchange because 10 31 is the IRS code section that  allows for that. 

All right. So what is the point of doing one of these. Well, the point is to be able  to defer the tax that you’d have from the gain of the sale of the rental property. If you had  just sold it and pocketed the cash. And when you say defer the tax, how exactly does that  work? Well, essentially, what happens is the new property that you buy carries forward the  tax basis. 

Of the old property that you sold. So can you give us an example to help our  listeners digest this? Yeah, for sure. So let’s say you had a bought a house that you bought  for 500,000. Uh, over the years, you’ve appreciated it by $200,000. So your current tax basis  is $300,000 in this property. Then you go in and you sell it for $700,000.

If you didn’t do a 10 31 exchange, you’d have $400,000 of taxable income. Uh,  which is a $700,000 sale price minus the $300,000 basis. Now, if you did do a 10 31  exchange, you’d have no textbook income. Uh, let’s say he bought a new rom property for  $700,000. Which in this case is a selling price of your old property. 

Instead of being able to depreciate the new property, starting at that $700,000  purchase price, you’d have to bring over the old basis from that previous property, which  was $300,000. So the game deferral really takes place in the form of reduce depreciation  deductions on the new property purchase. 

Right? So that’s the immediate impact, but what happens when they sell the new  rental property? So for the sake of example, uh, let’s say that I sold the property shortly  after the 10 31 exchange for $750,000. If they just sold it without doing another 10 31  exchange, then they would have a taxable gain of $450,000, uh, which is a sales price of 750  minus the reduced basis from the. 

Old rental property of 300,000. But what they could also do is just do another 10  31 exchange and roll the basis into yet another rental property. Hmm. That’s interesting. So  they could essentially keep doing this over and over and have a property where they were  using the basis from a property, you know, 10 exchanges ago. 

Yeah, pretty much. So, is there a circumstance where someone wouldn’t want to  do a 10 31 exchange on their rental properties? Yeah, there are a few, uh, one that comes to  mind is when the Varnell property was the primary residence of the taxpayer previously for  two out of the last five years. And that case it’s usually better to take the gain exclusion  that’s offered under the. 

Code section one 20, one of your personal residence up to 500,000. So you  probably owe some tax on a portion of the sale related to the rental activity, but you’d be  able to bring the vast majority of the money home on an after-tax basis. And wouldn’t be  held to the rigorous requirement of the 10 31 exchange. 

Okay. So that’s an important point here. You’d rather have gain exclusions than a  gain deferral in a 10 31, because the latter is mostly just kicking the can down. Yes. 100%.  Yeah. Okay. So you mentioned that 10 31 exchanges have some pretty strict or rigorous as  you phase it requirements. What exactly are the requirements of a 10 31 exchange to  achieve tax deferral? 

So these transactions have some strict timelines that you need to adhere to. Uh,  the first is a 45 day rule that requires you to tell the 10 31 trustee known as the  intermediary, which property you want to buy within 45 days of selling the old property. And  then you must buy that property. Meaning closing escrow within 180 days of the sale of the  old rental property. 

Hmm, the IRS does love time-based deadlines. So what else does the IRS required  for 10 31 exchanges? Well, the property be like kind, which in the way we’ve been talking  about, uh, means that it needs to be a rental real estate for rental real estate. You can’t 

exchange around real estate for. Uh, personal residence, um, title myself to be held in the  exact same way in the new property as it was in the old property. 

Uh, the replacement property. Or properties cannot exceed 200% of the value of  the previous property. Uh, and the new property can’t be less than 95% of the sales price of  the old property. Uh, and then when the purchase of the new property, doesn’t exactly  equal the sales price to the old property, there’s some potential for the part, uh, for part of  the transaction to be considered boot. 

Uh, yes, you always want to avoid the boot, whether it’s getting kicked out of  something, a boot on your car for a parking violation, or in this case, a boot in your ass from  the IRS. So tell our listeners a little bit about boot, right? So taxable, uh, boots, a term for  cash or cash equivalent being received from the 10 31 exchange. 

It could be actual cash or a reduced mortgage amount and the new property  compared to the old, uh, either way, if you receive boots as a result of the exchange, you  have to pay tax on it. Boom, Shaka Laka, John, very informative. And I think we just made it  under the five minute Mark to our listeners. If you have questions on 10 30, one exchanges,  or if you just need a new CPA and you like what you’re hearing from John, you can email him  at John at dark horse dot CPA. 

And once again, that’s John J O H N at dark horse dot CPA. So as always, we’d like  to thank you for tuning into TMS, or if you’re not into the whole brevity thing, taxes made  simple. Because there’s TMI and then there’s TMS.

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