Due to rising home values, when it comes time to sell real property that is part of a divorce proceeding, your clients may face hefty tax consequences. They may suggest to you that they can roll their capital gains from one property into another one, or if it is their homestead property in Florida, they may be exempt from tax liability up to certain amount. Some, or all of your clients’ tax liability may be preventable with a little strategic planning. However, other scenarios may not fit within the parameters of the IRS Code for taxable exposure.
Lately, I’m sure you’ve heard “we’re going to just do a 1031 like-kind exchange” as a tax-savings approach. It’s important to understand that not every client, and not every property sale qualifies for a 1031 exchange. Also, it is critical to ensure that your clients who qualify for the 1031 exchange don’t disqualify themselves due to mishandling of the funds from the sale of the property, or because they miss certain timelines. I’ve outlined some basic bullet points for you and your clients to consider. Please note that I am not a tax professional or CPA, and for anyone interested in pursuing a 1031 exchange, I cannot emphasize enough the importance of consulting with a qualified tax professional, especially in a divorce proceeding which makes these transactions even more complicated.
Basic Rules of 1031 Exchanges
● Only pertains to investment properties.
● Does not apply to primary residences or vacation homes unless they can qualify as an investment under a very small sliver of exceptions.
● Property must be exchanged for a “like for like” property, which means another investment property must be purchased, not a primary residence (again, a few exceptions apply).
● Identify a replacement property within 45 days of selling the relinquished property, in writing.
● Sale must be completed on the replacement property within 180 days after the sale of the relinquished property is completed, or the due date of the income tax return.
● The funds from the relinquished property cannot be touched by the principal, and cannot be deposited into any account held by the principal. A qualified intermediary or exchange facilitator must handle the exchange of funds. (I can direct you and your clients to various qualified 1031 exchange facilitators in our area should you need one)
Divorce-Specific Considerations
● Title – the replacement property must be purchased in the same taxable entity. For example, if a divorcing couple holds joint title to their rental property, and choose to do a 1031 Exchange, they must purchase the new rental property together.
● However, 1041 of the IRS Code pertains to tax-free transfers from one spouse to the other. Although not ideal, this could be a round-about way to accomplish a different form of tax savings. Your clients should be working directly with an experienced tax professional to guide them through this process.
● If one party wishes to move into their rental property after the divorce, there are a few things to keep in mind:
● If that property was acquired as a 1031 exchange, there are rules with which they must 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 owner-occupied, especially if they plan to sell the property in the future.
If there are any doubts, you should 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 to ensure they are in compliance with timelines and guidelines for 1031 exchanges and other tax advantageous real estate strategies.
I have been a real estate professional for over 20 years. I am a Certified Divorce Real Estate Expert (CDRE®) and a Certified Probate Real Estate Specialist (CPRES®). I work with Divorce and Probate law firms, and their clients to ensure the best and most profitable outcome every time.
If you have a case involving the sale or transfer of real property that needs to be listed, please contact me directly at 305.205.5232
My goal is to make your life easier.