SPEED ROUND: 1031 Exchanges

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.