Anomaly's Lazy 1031 Exchange Tax Strategy
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Summary
Often time investors default to a normal 1031 exchange. However, we often hear this is inflexible and causes panic.
A traditional 1031 exchange, also known as a like-kind exchange, allows real estate investors to defer paying taxes on the sale of a property by reinvesting the proceeds into another property. While this can be a useful tool for investors, there are several downsides to consider:
A Lazy 1031 exchange is a tax strategy used by real estate investors to defer taxes on the sale of a rental property. This strategy involves selling one rental property at a gain and then, in the same year, placing a second property in service. The second property must have an equal or higher basis than the first property to make the math work. Also - this will only work in years in which bonus depreciation is allowable.
A Cost Segregation study is then performed, and 80% depreciation is claimed in 2023. Since both activities are Passive Activities under IRC 469, the gain and the loss will offset each other.
Summary
Often time investors default to a normal 1031 exchange. However, we often hear this is inflexible and causes panic.
A traditional 1031 exchange, also known as a like-kind exchange, allows real estate investors to defer paying taxes on the sale of a property by reinvesting the proceeds into another property. While this can be a useful tool for investors, there are several downsides to consider:
- Limited Timeframe: Investors have only 45 days from the sale of their property to identify potential replacement properties and just 180 days to complete the purchase. This can be a tight timeline, especially in competitive markets.
- Limited Flexibility: The IRS has strict rules about what types of properties qualify for a 1031 exchange, limiting an investor's ability to diversify their portfolio or invest in other asset classes.
- Higher Purchase Price: In order to fully defer taxes, an investor must purchase a replacement property of equal or greater value than the property sold. This can limit an investor's ability to downsize or take profits from a sale.
- Administrative Burden: Completing a 1031 exchange requires careful planning and coordination with multiple parties
A Lazy 1031 exchange is a tax strategy used by real estate investors to defer taxes on the sale of a rental property. This strategy involves selling one rental property at a gain and then, in the same year, placing a second property in service. The second property must have an equal or higher basis than the first property to make the math work. Also - this will only work in years in which bonus depreciation is allowable.
A Cost Segregation study is then performed, and 80% depreciation is claimed in 2023. Since both activities are Passive Activities under IRC 469, the gain and the loss will offset each other.
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1How Does a Lazy 1031 Exchange Work?The Lazy 1031 exchange works by taking advantage of two tax strategies: the 1031 exchange and cost segregation. Here's how it works:
- Sell a rental property at a gain. Gain = sales prices less adjusted basis of the property. This strategy will NOT work for the sale of a primary residence.
- Purchase a second rental property with an equal or higher basis. Remember, basis is building only, so you must subtract the land value.
- Perform a cost segregation study on the second property.
- Claim 80% bonus depreciation under IRC 168k in 2023.
- Offset the gain from the sale of the first property with the loss from the depreciation of the second property.
Since most real estate investors are considered Passive investors (IRC 469) meaning they are not real estate professionals, they report their passive activities on Form 8582. Your passives losses accumulate on this form and they are offset by other passive income.
When you dispose of a property that was a "passive activity", the gain is considered a "passive activity gain". By statute, this gain MUST net against passive activity losses from ANY property (this is the common misconception).
Gains from passive activity sales net against passive activity losses from ANY source! -
2Benefits of a Lazy 1031 ExchangeThere are several benefits to using a Lazy 1031 exchange as a tax strategy:
- Tax Deferral - similar to a traditional 1031 exchange, this will allow you to defer capital gains and depreciation recapture taxes on the sale of a property.
- Flexibility - unlike a traditional 1031, you do NOT have to identify a property or involve an intermediary within 180 days. In fact, you could pull the the Lazy 1031 Exchange strategy off up until the last day of the same tax year!
- More Cash - depending on your equity in the original property, you may end up with significantly more cash in your pocket. Check out the Anomaly Lazy 1031 Exchange Calculator!
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3ConclusionA Lazy 1031 exchange is a tax strategy that can help real estate investors defer taxes on the sale of their rental properties while generating income from new rental properties. In years of Bonus Depreciation, this strategy provides more flexibility over a Traditional 1031 exchange.
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