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Article on Jul 11, 2023

Tax-Smart Strategies for Capital Gains in 2023

Using 1031 exchanges and qualified opportunity zones to reinvest the proceeds from the sale of an appreciated asset can defer...

Daniel Goodwin
Published by Kiplinger

What Are Qualified Opportunity Zones? - Provident 1031

Article on Jun 11, 2023

What Are Qualified Opportunity Zones? Important Details for Investors

Investing in blighted or up-and-coming “opportunity zones” offers some significant tax-deferral opportunities, and if you hold your investment for 10...

Daniel Goodwin
Published by Kiplinger

Article on May 28, 2023

Pros and Cons of Deferring Taxes with A 721 Exchange

A 721 exchange, or UPREIT, can be a great tax mitigation strategy for investors, though not everyone is suited to them.

Daniel Goodwin
Published by Kiplinger

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Common Questions

How do you compute the basis in the new property?

It is critical that you and your tax representative adjust and track basis correctly to comply with Section 1031 regulations.

Gain is deferred, but not forgiven, in a like-kind exchange. You must calculate and keep track of your basis in the new property you acquired in the exchange.

The basis of property acquired in a Section 1031 exchange is the basis of the property given up with some adjustments. This transfer of basis from the relinquished to the replacement property preserves the deferred gain for later recognition. A collateral affect is that the resulting depreciable basis is generally lower than what would otherwise be available if the replacement property were acquired in a taxable transaction.

Is my tax based on my equity or my taxable gain?

Tax is calculated upon the taxable gain. Gain and Equity are two separate and distinct items. To determine your gain, identify your original purchase price, deduct any depreciation, which has been previously reported, then add the value of any improvements, which have been made to the property. The resulting figure will reflect your cost or tax basis. Your gain is then calculated by subtracting the cost basis from the net sales price.

What are the Basic rules regarding Deferring Capital Gains with an Exchange?

Let us look at a basic concept, which applies to all exchanges. Use this concept to fully defer the capital gain taxes realized from the sale of a relinquished property:

1. The purchase price of the replacement property must be equal to or greater than the net sales price of the relinquished property, and
2. All equity received from the sale of the relinquished property must be used to acquire the replacement property.

To the extent that either of these rules is abridged, a tax liability will accrue to the Exchanger. If the replacement property purchase price is less, there will be tax. To the extent that not all equity is moved from the relinquished to the replacement property, there will be tax. This is not to say that the exchange will not qualify for these reasons; partial 1031 exchanges do in fact qualify for partial tax deferral. It simply means that the amount of any discrepancy will be taxed as boot, or non like-kind property.

Are Exchanges limited to one exchange and one replacement property?

This is another exchanging myth. There are no provisions within either the Internal Revenue Code or the Treasury Regulations which restrict the amount of properties which can be involved in an exchange. Therefore, exchanging out of several properties into one replacement property or vice versa, relinquishing (selling) one property and acquiring several are perfectly acceptable strategies.

Does Like-kind mean purchasing the same type of property which was sold?

Although the definition of like-kind has often been misinterpreted to mean that the property being acquired must be utilized in the same form as was the property being exchanged. In other words, apartments for apartments, hotels for hotels, farm for farm, etc. However, the true definition is again reflective more of intent than use. Accordingly, there are currently two types of property, which qualify as like-kind:

1. Property held for investment, and, or
2. Property held for a productive use in a trade or business.

Must all exchanges close at the same time?

No, although there was a time when all exchanges had to be closed on a simultaneous basis, they are rarely completed in this format any longer. In fact, a significant majority of exchanges are now closed as delayed or deferred exchanges.

Do all exchanges involve the swapping or trading with other property owners?

No, before delayed exchanges were codified in 1984, all simultaneous exchange transactions required the actual swapping of deeds and simultaneous closing among all parties to an exchange. Oft times these exchanges were comprised of dozens of exchanging parties as well as numerous exchange properties. But today, there is no such requirement to swap your property with someone else in order to complete an exchange. The 1031 exchange rules have been streamlined to the extent that the current process is reflective more of your qualifying intent rather than the logistics of the property closin

What are the Benefits of a 1031 Exchange?

A property owner or investor who expects to acquire replacement property subsequent to the sale of his existing property should consider an exchange. To do otherwise would necessitate the payment of capital gain taxes in amounts which can exceed 20%-30%, depending on the appropriate combined federal and state tax rates. In other words, when purchasing replacement property without the benefit of an exchange, your buying power is dramatically reduced and represents only 70%-80% of what it did previously.

What is a Tax Deferred Exchange?

A tax-deferred exchange represents a simple, strategic method for selling one qualifying property and the subsequent acquisition of another qualifying property within a specific time frame. Although the logistics of selling one property and buying another are virtually identical to any standard sale and purchase scenario, an exchange is different because the entire transaction is memorialized as an exchange and not a sale. And it is this distinction between exchanging and not simply selling and buying, which ultimately allows the taxpayer to qualify for deferred gain treatment. So essentially, sales are taxable and exchanges are not. Internal Revenue Code, Section 1031.

Because exchanging represents an IRS recognized approach to the deferral of capital gain taxes, it is important for us to appreciate the components and intent underlying such a tax deferred or tax free transaction. It is within Section 1031 of the Internal Revenue Code that we find the core essentials necessary for a successful exchange. Additionally, it is within the Like-Kind Exchange Regulations, previously issued by The Department of the Treasury, that we find the specific interpretation of the IRS and the generally accepted standards and rules for completing a qualifying transaction.

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Glossary Definitions

Treasury index

An index that is used to determine interest rate changes for certain adjustable-rate mortgage (ARM) plans. It is based on the results of auctions that the U.S. Treasury holds for its Treasury bills and securities or is derived from the U.S. Treasury’s daily yield curve, which is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market.

transfer tax

State or local tax payable when title passes from one owner to another.

transfer of ownership

Any means by which the ownership of a property changes hands. Lenders consider all of the following situations to be a transfer of ownership: the purchase of a property “subject to” the mortgage, the assumption of the mortgage debt by the property purchaser, and any exchange of possession of the property under a land sales contract or any other land trust device.

title search

A check of the title records to ensure that the seller is the legal owner of the property and that there are no liens or other claims outstanding.

title insurance

Insurance that protects the lender (lender’s policy) or the buyer (owner’s policy) against loss arising from disputes over ownership of a property.

title company

A company that specializes in examining and insuring titles to real estate.

title

A legal document evidencing a person’s right to or ownership of a property.

third-party origination

A process by which a lender uses another party to completely or partially originate, process, underwrite, close, fund, or package the mortgages it plans to deliver to the secondary mortgage market.

tenancy in common

As opposed to joint tenancy, when there are two or more individuals on title to a piece of property, this type of ownership does not pass ownership to the others in the event of death.

sweat equity

Contribution to the construction or rehabilitation of a property in the form of labor or services rather than cash.

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