Category: Advisory

Simply put, the 1031 exchange is an exchange of one real estate investment property for another that allows capital gains taxes to be deferred. By exchanging your appreciated investment or rental property rather than selling it, you may avoid immediate tax on the potential gain.

Learn how Savvy Investors Use Like-Kind Exchange to Defer Capital Gains Taxes.

You can defer tax on the gain through a “like-kind” exchange. Internal Revenue Code § 1031 provides the rules for this. IRC Section 1031 has many moving parts that real estate investors must understand before attempting its use: A taxpayer may sell an investment or business property (relinquished property) and defer tax on the gain if the taxpayer reinvests in a similar property (replacement property). Nonrecognition treatment doesn’t apply to personal property and real property held primarily for sale.

The reason for the nonrecognition treatment is that the taxpayer continues to be invested in the same kind of property and has not cashed out of a real estate investment or business. Therefore, taxes are deferred until the taxpayer does cash out and sells the property outright.

This article will provide an overview of the rules related to a like-kind exchange. It should be noted that in 2021, the Biden Administration sought to revise the benefits of the tax deferral, but those changes were not approved under the Build Back Better legislation. Also, the Inflation Reduction Act of 2022 which was recently passed in August did not alter the rules either. However, taxpayers need to be apprised of this and monitor this potential issue.

Basic Requirements of a Like-Kind Exchange

IRC § 1031 is very form-driven, and taxpayers must satisfy several requirements, or the deferral fails. One important requirement is that the transaction must be structured as an exchange. This means that taxpayers cannot sell, obtain the proceeds, and then buy a replacement property. Rather, they must either trade the property directly or use the deferred exchange rules described below.

Timeline

In a deferred exchange, a taxpayer must identify the replacement property within 45 days (the identification period) and receive it within 180 days (the exchange period). While the tax law allows deferred exchanges, it requires time limits for them to occur.

Basis

Taxpayers take the same “basis” in the replacement property that they had in the relinquished property. Like-kind exchanges are reported on Form 8824 – and this form tracks the basis of the relinquished and replacement properties.

When a property is exchanged solely for another property of a like-kind, computing the basis in the replacement property is straightforward. In that case, the taxpayer’s basis in the replacement property is the taxpayer’s adjusted basis in the relinquished property.

However, the computation of basis is more complicated when the exchanged properties are not equal in value, so money or other property (boot) is transferred or received. If “boot” is involved, the gain is recognized, but only up to the amount of boot received in the exchange.

Also, if the property that is exchanged is subject to debt from which the taxpayer is being relieved, the amount of the debt is treated as boot. The theory is that if someone takes over your debt, it’s the equivalent of providing cash.

Deferred Exchanges

As noted above, for like-kind exchange treatment to apply, there must be an exchange of real properties that are of like-kind and have been held for productive use in a trade or business or for investment. The transaction must be an exchange – not a transfer of property for money that is then used to acquire the replacement property. A sale of property followed by a purchase of another property (that is of a like-kind to the property sold) doesn’t qualify for nonrecognition of gain or loss under IRC § 1031.

Often the properties cannot be exchanged immediately or simultaneously. For this reason, the law permits deferred exchanges. A “deferred exchange” occurs when a taxpayer, under an agreement, transfers the property and later receives like-kind property. To qualify as a deferred exchange, the taxpayer must identify the replacement property before the end of the “identification period,” and receive the replacement property before the end of the “exchange period, as described above. Taxpayers can accomplish a deferred exchange using safe harbor transactions such as a qualified intermediary or guarantee arrangement. Moreover, the transactions become more complex when they involve related parties or Delaware Statutory Trusts.

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While the fundamental principles of the like-kind exchange appear straight-forward, complexities can arise with the calculation of basis and depreciation along with the use of deferred exchanges and the application of the safe harbor rules.

If you would like to discuss the benefits, rules and strategies related to like-kind exchanges, please contact RVG & Company today! (954) 233 1767 | [email protected]

DISCLAIMER: The information covered in this article is not intended to provide and should not be relied on for tax, accounting, or legal advice; instead, all information, content, and materials informed are for informational purposes only. Consult your tax, legal, or accounting advisor before taking action. If you require advisory services, please contact our office.

As we approach Q4, now is the perfect opportunity to review your current situation and implement tax-saving strategies to reduce taxes for the coming year. These steps must be taken before the end of the year to reflected in your tax return due in April. This article will outline several steps that can be taken to minimize 2022 taxes and for taxpayers to establish a fiscal and financial plan for their future.

Simple Strategies that can Provide a Significant Benefit for 2022 and Future Years

Maximize Retirement Benefits

In 2022, contributions to 401K and 403(b) plans can reduce taxable income up to $20,500 (individuals that are 50 or older can add $6,500 to the basic workplace retirement plan contribution). For example, an employee earning $100,000 in 2022 who contributes $19,500 to a 401K, reduces their taxable income to only $79,500. Even small business owners can set up retirement plans such as a SIMPLE IRA, SIMPLE 401K, SEP, and a Solo / One Participant 401K that provide tax savings to the business owners and the employees – while providing a retirement program for the future.

Individuals that do not have a retirement plan at work may obtain tax savings by contributing up to $6,000 ($7,000 for those 50 and older) to a deductible IRA.

Use a Health Savings Account (HSA)

Employees with a high-deductible health insurance plan can use an HSA to reduce taxes. As with a 401K, HSA contributions (which may be matched by the employer) by payroll deduction are excluded from the employee’s taxable income. For 2022, the maximum contribution is $3,650 for individuals and $7,300 for families. These funds can grow without the requirement to pay tax on the earnings. An extra tax benefit of an HSA is that when it is used to pay for qualified medical expenses, withdrawals are not taxed.

Minimizing Capital Gains Taxes

Mutual Fund Distributions – If you are considering the purchase of a mutual fund at the end of the year, delay buying it until after the dividend record date to avoid being taxed on capital gain distributions. Towards the end of the fourth quarter, mutual funds generally declare capital gain distributions. These gains are subject to tax even if reinvested and even if the shares value is less than your purchase price. An alternative to a mutual fund is a passively managed exchange-traded fund, which typically has less capital gain distributions.

Charitable Donations of Appreciated Stock – Consider donating publicly traded stock. Qualified appreciated stock is normally publicly traded stock and is eligible to be deducted at its fair market value. Charitable gifts of real property and closely held stock can only qualify for a donation up to their basis. The publicly traded stock must be held for more than one year. By doing this, taxpayers obtain a double benefit of receiving a deduction equal to the full fair market value of the stock and they avoid paying the capital gains tax on the appreciation. It should be noted that the contribution of long-term appreciated property / qualified appreciated stock is generally limited to 30% of adjusted gross income. Thus, the contribution should be timed so it is made when your income is higher.

Unrealized Gains and Losses – Offset the tax impact of any realized gains taken this year by harvesting losses in your portfolio or, in some cases, realizing gains to offset losses (for example, to reduce concentrated stock positions). Any harvested tax losses not offset by gains in 2022 can be carried forward to future tax years throughout an investor’s lifetime. Taxpayers that harvest losses must avoid the wash-sale rule that will disallow losses. This rule provides, that if a taxpayer sells a security at a loss and buys the same security within 30 days of the sale – that loss will be disallowed.

Review Withholding and Estimated Tax Payments

Underpaid withholding taxes and estimated taxes may be subject to penalties. If you are potentially subject to these penalties, consider increasing withholding taxes from wages and bonuses in the fourth quarter. Amounts withheld in the fourth quarter are deemed to be paid equally over each quarter, which can minimize or eliminate a penalty that may be related to the three prior quarters. Taxpayers that have tax withheld from their wages may generate additional income from investment income or real estate holdings that require additional tax through withholding or estimated payments. To avoid a penalty either 90% of the tax shown on your current return or 110% of the tax on your prior year’s tax return must be paid, certain limitations do apply.

Wills and Trusts

While significant estate and gift planning techniques are beyond the scope of this article, taxpayers should be reminded to review wills and trusts to ensure that they reflect any changes in their personal or financial situation that occurred during 2022 or are likely to occur in 2023. It should be noted that in the Tax Cut and Jobs Act of 2017, the estate, generation-skipping transfer, and gift exclusion amount increased from $5 million to $10 million. Also, the TCJA retained the “step-up” based on fair market value for appreciated assets that are transferred by a decedent. While revisions to this rule have been proposed – it is still available.

RVG &Company

While the fundamental principles of the like-kind exchange appear straightforward, complexities can arise with the calculation of basis and depreciation along with the use of deferred exchanges and the application of the safe harbor rules.

If you would like to discuss the benefits, rules and strategies related to like-kind exchanges, please contact RVG & Company today! (954) 233 1767 | [email protected]

DISCLAIMER: The information covered in this article is not intended to provide and should not be relied on for tax, accounting, or legal advice; instead, all information, content, and materials informed are for informational purposes only. Consult your tax, legal, or accounting advisor before taking action. If you require advisory services, please contact our office.

If you inherited an IRA, 401K, or another type of retirement plan account after 2019, you may need to make annual account distributions and pay taxes. A new law also requires the entire balance of the plan to be distributed to you within 10 years. These distributions are known as Required Mandatory Distributions (RMDs). There are some exceptions to the 10-year rule, such as if the beneficiary is a surviving spouse, a minor child, or a person with a disability or chronic illness. This article will focus on changes to the RMD rules under the SECURE Act that went into effect on January 1, 2020 (also known as the Setting Every Community Up for Retirement Enhancement Act of 2019).

Background

Before the SECURE Act, the owner of an IRA was required to take RMDs beginning in the year they reached the age of 70 ½. The SECURE Act relaxed that rule and allowed owners to delay taking the RMD until age 72.

Also, before the SECURE Act, if a non-spouse inherited a retirement account the proceeds could have been distributed over the lifetime of the beneficiary. This was referred to as “stretching an IRA”. Under this concept, the beneficiary could reduce their tax burden on the inherited account, if they delayed the RMD until they retired – when presumably they have less income. This strategy was helpful if the account was inherited before retirement and RMDs were delayed until later years.

As noted above, the SECURE Act now requires beneficiaries that inherited a retirement account on or after January 1, 2020, to withdraw all the assets from the plan within 10 years of the death of the original account holder. However, the withdrawal rule is different when the original owner was receiving RMDs before their death.

IRS Proposed Regulations for Inherited Retirement Accounts

On October 7, 2022, the IRS issued a Notice that said it would delay the enforcement of a regulation issued in February that is related to beneficiaries taking required withdrawals from inherited retirement accounts. The IRS issued the Notice because many taxpayers and tax professionals found the February regulation to be confusing and it contradicted prior guidance by the IRS. The penalty relief applies to taxpayers that inherited retirement accounts in 2020 or 2021.

When the SECURE Act put the 10-year rule in place, taxpayers and tax professionals reasonably interpreted the new law to mean that beneficiaries of inherited retirement accounts could wait until the 10th year after the original owner’s death to withdraw all the assets. In other words, the beneficiary did not have to take an annual RMD every year for 10 years – they could do a lump sum distribution in year 10. In this regard, taxpayers relied upon guidance issued by the IRS in Publication 590B, published in May of 2021 that provided the basis for this application of the 10-year rule.

In February of 2022, the IRS issued a regulation that would require the heirs to take RMDs in cases where the original owner of the retirement account had taken their RMDs before death. This regulation conflicted with IRS guidance in Publication 590B. Consequently, many taxpayers did not take RMDs in 2020 or 2021 concerning IRAs and other retirement accounts that were inherited in 2020. The failure to take an RMD results in a 50% additional tax on the RMD amount that should have been taken. This additional excise tax is often referred to as a penalty.

During the 90-day comment period for the February regulation, the IRS received several comments from taxpayers and tax professionals claiming that they were not certain if they should take an annual RMD concerning retirement accounts that were inherited in 2020 and 2021. In response to the comments the IRS issued the Notice on October 7, 2022, that states that the February regulation would not apply until 2023. Therefore, the 50% tax/penalty would not apply to beneficiaries of IRAs that failed to take an RMD for retirement accounts where the original owner took RMDs before their death. However, in 2023, these beneficiaries must take the RMD or face the 50% additional tax. The IRS Notice also provides that if a beneficiary paid the 50% excise tax/penalty for a 2020 or 2021 RMD, they may request a refund.

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If you have inherited a retirement account after 2019 and would like to discuss the RMD and tax filing requirements to avoid a 50% penalty, please call RVG & Company at (954) 233-1767.