A 1031 exchange is a transaction that allows you to exchange business or investment-use real estate for another like-kind property without incurring capital gains tax. By completing these transactions, you have the potential to avoid paying these taxes for…well, for forever, provided the transactions are performed correctly and within IRS rules and regulations.
A question we are often asked at Midland is, “Should I 1031 exchange my IRA-owned property?” The short answer is no—but let us explain.
You own real estate investments within your retirement account, and you’ve heard of a little known tax provision called IRC Section 1031 that can be used to save or completely defer taxes when selling and re-investing in investment property via 1031 exchanges. Sounds like a good plan, and it is, unless you’re dealing with property already owned by your IRA.
Why not? Well, the income derived from the assets held in your retirement account generally flow tax free into the retirement account. Therefore, there is usually no need to engage in a 1031 exchange for real estate investments that are already reaping tax-free or tax-deferred benefits in an IRA. So, typically, 1031s are used by people who are investing in property that is not held in a retirement account.
However, there is an exception to this general rule: Your retirement account may want to engage in a 1031 exchange if debt-financing was involved in the purchase of the property, or if the property is held partially by the retirement account and partially by an individual. In this situation, it may make sense to 1031 exchange the property, or at least engage in a 1031 exchange for the portion of the property that is not owned by the retirement account.
All things considered, it is always best to talk with a tax advisor, CPA, or attorney before engaging in a 1031 exchange, as certain parameters must be met for the property to qualify for a 1031 exchange.