If you sell land at today’s high land prices, you might face some large capital gains taxes. If you know that you want to purchase more land though, the US government has provided a way to help you defer those taxes.
The IRS outlines its 1031 Deferred Like-Kind Exchange in this fact sheet. The rules are complex, and I’m not going to get into them in this post. Instead, I want to talk about advance planning, because if you miss this one important step, you may not ever get the chance to even attempt a 1031 transfer.
1. Talk to your accountant. Your accountant should be able to help you understand what a like kind exchange is and how it may affect your tax situation. Only your accountant knows your complete tax history, so your accountant is the best suited to help you determine whether it would be in your best interest to attempt to defer capital gains taxes or if the situation is ripe for you to pay the taxes in the current year. Deferred taxes always sound good, right? Well, there may be situations where it would be better to take the gain now. For example, long-term capital gains tax rates are pretty low right now. Or if you have capital losses, maybe you want to offset those with a gain on the land sale and get the cash in your pocket. Only your accountant can help you decide.
2. Talk to your lawyer. 1031 exchanges require you to follow specific steps in order to qualify, and these steps are very different from the normal land sale. There are time windows, deadlines, requirements of what and when to purchase, closing requirements, and rules about constructive or actual receipt of proceeds from the sale (you and your attorney shouldn’t ever have access to the money, by the way). Most closings do not involve 1031 exchanges, so your lawyer can’t help you with one if you don’t mention it.
3. Talk to your real estate agent. Specific language should be inserted in your purchase agreement. Make sure your real estate agent knows that you’re looking to conduct a like-kind exchange. If you already have a purchase agreement, you may consider amending it to add the 1031 language. 1031 exchanges are sophisticated business deals. I’d recommend against trying to do-it-yourself on this transaction.
4. Find a qualified 3rd party intermediary. Remember when I said you and your lawyer shouldn’t ever have access to the money? That’s why you need a third party intermediary. One of the big companies in the industry is Starker Services. I don’t have any relationship with them, but I know they will answer questions over the phone for landowners, investors, and anyone else looking for 1031 information.
5. Don’t close the sale until you have everything set up. The closing is basically the end of your sale. Closing agents are required to report sales to the IRS, and they will ask you to sign a form indicating that they have your correct social security number to report your sale price. This is a clue for you…if you are advised that the sale will be reported for tax purposes and you don’t yet have the 1031 process underway, your closing agent likely doesn’t know that you are considering a 1031 exchange. If you close (sign documents and exchange money) before you have your 1031 exchange set up, you could be disqualified from making the exchange.
6. Act quickly. There are tight deadlines written into the statute. Make sure you understand them before you start the process.
My most important advice: Set up a good team of people to help you with your exchange. You’ll need an accountant, a realtor, a lawyer, and a third party intermediary. Make sure each of these professionals are involved from the beginning so that you don’t miss any steps. And most importantly, make sure that you tell your team members that you want to exchange like-kind property through a 1031 exchange. While 1031 exchanges happen frequently, they are not the norm in many areas, so your team needs to know you’re planning one so they can best advise you.