Basics of 1031 Exchange
An IRC Section 1031 exchange is a complex transaction in which investment property is either directly exchanged for another investment property or an investment property is sold. Then another property is acquired using the proceeds from the sale. In either variation, the purpose is to defer capital gains taxes ordinarily owed on profits. 1031 exchanges must follow many rules and regulations to be valid. Investors usually hire a specialist to provide consulting to ensure compliance.The Tax Cuts & Jobs Act nearly eliminated 1031 exchanges, but it, fortunately, preserved real estate exchanges. It removed exchanges of personal property. So now it’s no longer possible (at this time) to conduct 1031 exchanges involving personal investment property.
Why Divorce is Relevant
Why would divorce be relevant for 1031 exchanges? The answer is that the owner conducting 1031 exchanges must remain the owner throughout the transaction. In other words, if person A owns a piece of investment real estate and conducts a 1031 exchange, person A also must be the one to acquire the replacement property. If a couple divorces, this can cause issues regarding how property is titled or held. After a divorce, you may no longer hold a given piece of property in the same manner, which is significant in a 1031 exchange context.
Conducting an Exchange Before Divorce
If a couple wants to conduct an exchange using their investment real estate, and that real estate is jointly owned (i.e., title held as a married person), then that couple will need to both sell and acquire new real estate as a married couple. The entire exchange can fail if the same entity does not sell and acquire property in an exchange. If a couple wants to divorce but also wants to conduct an exchange to maximize their finances, the couple can structure their transaction accordingly. First, the couple would need to sell the property as a married couple and then acquire a replacement property as a married couple. They need to achieve these actions within 180 days. Then, after satisfying the “holding requirement” for the acquired property, the parties can execute the divorce and handle the newly acquired property as they see fit.The parties can liquidate the property and then divide the proceeds. Or, one party may transfer all their interests in the property in exchange for cash. The parties may even continue holding the property together, but as partners in an LLC, as opposed to a married couple or as joint tenants in common.The key points that readers need to take away are as follows: (1) to make matters as simple as possible, couples should avoid getting divorced while conducting an exchange, (2) getting divorced immediately after an exchange may also cause issues with the holding requirement for newly acquired property, (3) couples should either divorce well before conducting an exchange or well after conducting an exchange.
Contact the Murphy Law Firm for Additional Information
Conducting 1031 exchanges is often complex and requires expert counsel. If you’re contemplating divorce and may conduct an exchange soon, you’ll want to consult with an expert before finalizing anything. If you’d like to learn more, reach out to The Murphy Law Firm today by calling 240-493-9116.