Due to the significant rise in home values in the United States over the last few years, your clients may face hefty tax consequences when selling real property. They may want to roll their capital gains from one property into another. Some tax implications may be preventable with a little strategic planning, while others may not fit within the Internal Revenue Service Code parameters for taxable exposure.
You might have recently heard property owners saying, “We’ll just do a 1031 exchange” to save on taxes. While this strategy can be advantageous, it’s crucial to grasp the qualifications and process to avoid pitfalls. Ensuring your clients don’t disqualify themselves is key—whether by mishandling sale proceeds or missing essential deadlines they weren’t aware of. Understanding these nuances will help navigate the complexities of a 1031 exchange effectively.
Here are some basic bullet points for you and your clients to consider. The author is not a tax professional and recommends that anyone interested in pursuing a 1031 “like-kind property” exchange consult with a qualified tax professional. This is especially true for divorce proceedings as these transactions get even more complicated.
The Basics of 1031 Exchanges in Divorce Proceedings
Here are some of the basic rules of 1031 Exchanges:
- They only pertain to the sale of an investment property;
- They don’t apply to a primary or personal residence or vacation home unless they can qualify as an investment under a very small sliver of exceptions;
- The exchange of real property is a “like for like” or “like-kind” exchange, which means another investment property must be purchased, not a primary residence (again, a few exceptions do apply).
- A new replacement property must be identified within 45 days of selling the relinquished property;
- The sale of the property must be completed within 180 days after the closing date of the relinquished property, or the due date of the income tax return; whichever is first.
- The funds from the relinquished property cannot be touched by the sellers. A qualified intermediary or third-party exchange facilitator must handle the exchange of funds.
Related: The Personal Property Dilemma in Divorce
Divorce Specific Considerations
- Title-replacement properties must be purchased by the same taxable entity. For example, if a married couple holds a joint title to their rental property and chooses to do a 1031 Exchange, they must purchase the new rental property together, which is not realistic in a divorce setting;
- However, section 1041 of the IRS Code pertains to tax-free transfers from one spouse to another. Although not ideal, this could be a workaround to accomplish the desirable tax cuts or savings by divorcing or former spouses. Without question, your clients should be working directly with an experienced tax code professional to guide them through this complex scenario.
If one party wishes to move into their rental property after the divorce, there are also a few things to keep in mind:
- If that property was acquired in a 1031 exchange, there are rules with which the parties need to comply;
- If they did not acquire their rental property as a 1031, they should consider the tax consequences of converting the character of that property from a rental to an owner-occupied, especially if they plan to sell it in the future.
Please keep in mind that this is a very brief overview of the 1031 rules. Ideally, you will refer your clients to the IRS Fact Sheet for 1031 Exchanges for more information. They should also be working with a qualified real estate professional who understands the intricacies of these transactions. This will ensure they comply with timelines and guidelines.
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The primary objective should always be to streamline the process, minimizing stress and delays while maximizing profits for clients selling real property in probate or divorce cases.
Partnering with a qualified and certified real estate professional ensures that every necessary step is meticulously managed, securing the best possible outcome for the sale of property during these proceedings. This collaboration keeps both the law firm and its clients well-informed and empowered to make optimal decisions, ultimately enhancing the reputation of their legal counsel.
Our mission is to simplify your life with expert, professional guidance.
Related: Handling Difficult Legal Client Types: A Guide for Lawyers
About the Author
Madelin Espino is a real estate professional with over 20 years of experience. She is also a Certified Divorce Real Estate Expert (CDRE), a Certified Divorce Specialist (CDS), a Certified Probate Real Estate Specialist (CDRES), and a Certified Short Sale Agent. She regularly works with divorce and probate law firms and their clients to ensure the best overall experience, and that all necessary steps occur at the appropriate time to reach the most mutually beneficial outcome. She can be reached at madelin@madelinespino.com, or 305.205.5232.
Related:
- The Personal Property Dilemma in Divorce
- Unveiling the Future of International Justice: A Must-Attend 2024 Amsterdam CLE Conference
- Handling Difficult Legal Client Types: A Guide for Lawyers
