Section 1031 in Arizona
With many employers moving to the state, Arizona has one of the hottest real estate markets in the United States right now. If you purchased property here before the boom, you could stand to make a lot of money by selling that property.
But, since values have gone up so much, that means that you might then be saddled with a large capital gains tax bill. That is unless you opt to use a 1031 exchange and defer paying taxes on those gains. Let’s take a look at how Arizona 1031 exchanges work.
What is a Section 1031 Exchange?
A section 1031 exchange is a tax deferment strategy that allows real estate investors to sell one or more properties and use the proceeds to immediately invest in other properties, without paying capital gains taxes on the sale amount of the relinquished property.
If you later sell a property that you have acquired in a 1031 exchange, you will have to pay the capital gains tax at that time, unless you are selling it in another 1031 exchange. There is no limit to the amount of 1031 exchanges you can conduct.
Who Qualifies in Arizona for Section 1031?
Any taxpaying entity in the United States is eligible to complete a 1031 exchange. This means that individuals, C and S corporations, LLCs, general or limited partnerships, trusts, and so forth can all enter into a 1031 exchange. There are, however, several rules that must be followed.
Recent Changes to 1031 Rules
Originally, 1031 exchanges could be used to exchange personal and intellectual property as well as real estate, including things like franchise licenses, aircraft, machinery and equipment, patents, and so forth. However, the 2017 Tax Cuts and Jobs Act reduced the scope of 1031 exchanges to only allow for the inclusion of real estate property. But, the act also provides a full expensing allowance for some types of tangible personal property, which helps counteract the severity of the rule change.
What is the potential for 1031 exchanges to be eliminated under the Biden administration?
Biden has proposed to eliminate 1031 exchanges for investors who make more than $400,000 in annual income and eliminate the step-up provision for properties that are passed to heirs, which in the past would eliminate any owed capital gains taxes. However, this proposal has not yet been passed into law, although it may becoming.
Arizona 1031 Exchange Rules
Unlike some other states, Arizona does not have state-specific 1031 exchange rules, but of course, the federal rules apply. One of these rules is that the properties being exchanged must be like-kind, which means that they must be similar in nature or characteristics, although they can differ in quality. So, this means that a wide variety of property types can be exchanged with one another, including vacant land, apartment complexes, single-family homes, industrial properties, business or storefront properties, and so forth.
Additionally, a qualified intermediary (QI) must be used to manage the 1031 exchange. The QI will accept the proceeds from the sale of the relinquished property and hold that amount in trust until it can be transferred to the owner of the replacement property so that the money never actually enters your account and you can defer the taxes. The QI is also required to hold certain insurance policies to perform the duties, and they cannot be directly related to either party of the exchange.
Read More: 1031 Exchange Rules Infographic
Know the Timing Rules
There are four types of 1031 exchanges, but the most common type is a delayed exchange. This type has some timing rules, including that you have 45 days from the date of sale of the relinquished property to identify potential replacement properties in writing to your QI and 180 days from the date of sale of your relinquished property to close the sale of the replacement property or properties.
Other types of 1031 exchanges have different timing requirements. For example, simultaneous exchanges require that the sales of both the relinquished and the replacement properties happen simultaneously. A reverse 1031 exchange has the same 45-day and 180-day rules as a delayed exchange, but it works in reverse – the replacement property is purchased first and the relinquished property must be identified within 45 days and sold within 180 days.
Arizona 1031 Exchange FAQs
Here are the top questions asked about 1031 exchanges in Arizona. Feel free to contact us anytime with your questions.
1031 exchanges allow you as an investor to easily diversify your investment portfolio, grow your wealth, move investments from one state to another, a transition from high management duties to lower management duties, and even plan your estate.
Only real estate that’s used for business or investment purposes qualifies for a like-kind exchange. However, a wide variety of property types can be exchanged. For instance, the vacant property can be exchanged for a single-family home rental, or an office building can be exchanged for an apartment complex. No primary residences or personal property can be exchanged.
1031 exchanges offer many benefits, but they aren’t always the best choice for every investor. Consult your tax professional or contact our team of experts here at TFS Properties to determine if a 1031 exchange will be in your best interest as an investor.
Beware of Schemes
All investors should beware of those who promote 1031 exchanges as “tax-free” since in reality, they are simply a tax deferral strategy and you will eventually have to pay taxes on the gains. Additionally, avoid entering into exchanges with those who are attempting to trade ineligible properties such as primary homes or vacation homes that are not considered eligible. And of course, never attempt to claim an exchange when you’ve already received the cash proceeds of a sale.