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The Times are Exchanging

1031 Exchange

The tax consequences of trading spaces are fairly painless if you participate in an Internal Revenue Code Section 1031 tax deferred exchange. Such exchanges allow the seller to defer taxable gain on investment properties. Key to this concept is that taxes are deferred which means, of course, that at some point they must be paid.

Play by the Rules

While specific rules are a quick “Google” or “Yahoo” search away, my “go-to gal” is Julie Bratton of Old Republic Exchange. During our recent Real Estate Wine’d Down, Julie reminded us of critical steps and suggestions which aren’t necessarily part of any published guidelines. Your purchase agreement is one of the first places an exchange can get into trouble. In order to comply with IRS requirements, specific language indicating both parties agree to participate must be included, or the exchange could be disqualified. A simple recitation of the agreement will suffice. But expanded language is required to fully protect the seller, especially on the buying “leg” of the exchange. Remember, an exchange must be like-kind for like-kind which simply means real estate for real estate; land for house, house for condo, etc.

Time is Ticking

Julie reminded us that there are strict time limits (45 days to designate and 180 days to close) related to the exchange. It is a good idea to designate multiple exchange properties. Hawai`i is infamous for title and survey problems. Delays in resolving these could easily extend closing beyond the allowable time.

Tip: Check property titles early.

Foreign Exchange

As part of previous conversations, Julie reminded me that transactions with foreigners can be quirky. The IRS requires that all foreigners involved in real property transactions must have a Tax ID number. They should apply early because a delay could cause the process to exceed the allowable timelines. Remember, key to every exchange is the concept of “control of funds”. The party relinquishing the funds (the seller, then buyer) is not allowed to touch either proceeds of the sale (the first leg) or funds being held to complete the purchase (the second leg). An Exchange Accommodator must be used.

Tip: Exchange accommodators are not regulated in Hawai`i, so choose your third party intermediary carefully.

Keep in Mind

Even though taxes are deferred, it is widely held that an investment property may be converted to personal use after a period of investment use. Investment use for one to two years is probably fine but as Julie reminded us, the taxes on previous sales is still due. Death moves the tax basis (the taxable amount) forward to the date of death. For this reason, Julie recommends that heirs consider selling at that time. Otherwise future appreciation will be fully taxed.

Tip: Most exchanges are fairly straight forward but it’s always advisable to consult a financial advisor and an attorney versed in exchanges. Not all are!

Remember, builders of spec homes are dealers. Such sales do not qualify for tax deferred exchanges.

Tip: When it comes time for your next exchange, use a Realtor® who understands the basics especially as relates to our Hawai`i market! 

Join Us!

Quick reminder, join us online for our next Real Estate Wine’d Down. Just email me for an invite!

About the Author

Denise Nakanishi

Denise Nakanishi is a REALTOR Broker with Hawai'i Life. Denise Nakanishi is one of Hilo's most acclaimed real estate agents. She reached the rank of Major in the US Army and is now known by many as "Major Mom." The nickname fits–not only does Denise bring the discipline and mission-oriented attitude you'd expect, she's also caring and compassionate, always looking out for her clients like they're her own family. Having made the Big Island her home since 1987, Denise combines her extensive knowledge of the area with a sharp focus on customer service and the results speak for themselves. She's the recent recipient of the Best East Hawai`i, Best of Zillow, Chairman's Circle Award, President's Circle, Top Producing Agent since 2001, and Realtor of the Year awards. Denise stays ahead of the curve because she's passionate about education–she served as Education Chair for Hawaii Island REALTORS® for many years. She's one of Big Island's best real estate resources, known for her weekly article in the Hawaii Tribune Herald. Denise leads Team Nakanishi for Hawai`i Life, who is committed to their family, work, and community. In her little time away from work, Denise is a committed runner and Grandy. She also devotes many hours to various Veterans' Organizations, the East Hawaii Cultural Center, and the Hawaii Island REALTORS®. You can email me at denise@hawaiilife.com or via phone at (808) 936-5100.

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