1031 Exchanges can be used to defer losses? Huh?
by Tom on May 18, 2009
in Guest Posts, Market Musings, Realtor Thoughts
This post is another guest post from my friend Jeff Brown. Jeff’s a common sense investment Realtor who has done more Straight Talk in his career than many people I know. Check out more of his writings at Bawld Guy Talking or at Brown & Brown Inc.
Real Estate Investors — 1031 Exchanges Can
Be Used To Defer Losses
Posted @ 6:53 pm – Filed under 1031 Exchanges
What? Huh? What would possess anyone to defer a loss for Heaven’s sake? There are situations in which a tax deferred exchange deferring a loss would make excellent tax planning sense. Sometimes, believe it or not, investors have executed exchanges without knowing ’till the end they’re in fact not deferring a gain, but, horror of horrors, a loss. No really, I’m not kiddin’.
First of all it’s crucial the taxpayer understand a 1031 basic truth. Once you’ve done what it takes to qualify for tax deferral, it doesn’t matter whether it was taxes to be paid by you, or tax savings to be enjoyed. Crazy, no? Once you’ve filed a tax return with a transaction structured as a qualified 1031 — there’s no changing your mind. It is what it is. The gain, or in this case, the loss is deferred.
Now you know why I’m always banging away at folks to ‘call the guy’, which would of course include your tax pro when contemplating a strategy of tax deferral. Sure, I know the law and regs, even a large part of the minutia of which I talk much about here, and about which most folks don’t know to ask. Yet I still insist clients speak to their tax people or have them speak to me to ensure we’re all on the same page. My experience is chock-full of examples where clients’ tax pros bring ‘new’ facts to the table that saves the shared client from a self destructive strategy.
Oh, you wanna hear one? OK…
How ’bout the client who ‘computed’ his capital gain without the understanding of ‘adjusted basis’ and it’s impact? “Well, I paid X and sold for Y, therefore my gain is Z.” Wrong 6-figure tax bill breath. His adjusted basis effectively lowered his ‘what I paid’ number by almost a half million bucks! Uh, seems the calculations neglected to include the factoid he’d twice used 1031’s — ultimately ending up with the property in question. Not only that, but since he’d acquired the initial property in 1985 his depreciation was off the charts huge, and relatively short lived compared to today’s law. If I remember correctly, he’d barely gotten under the line, qualifying for a 15 year life. Then he traded again in 2001. Then traded into the subject property in early 2003. He came to me around Jan-Feb of 2005.
His actual gain would’ve cost him, according to his CPA, who was a real firecracker, and a funny lady, easily over $100,000. Our client wasn’t amused. His figures showed a tax bill literally in the ‘chump change range’. Go figure — pun intended.
But why would one defer a loss on Purpose?
This is where it gets way simple.
You might be protecting some other ‘loss carry forwards’ which make more sense to use time wise. It’s also common to defer a loss when you’re fairly sure you’ll be in a higher tax bracket or at least making a bunch more income down the road. Maybe you’re planning to take a good size capital gain in a couple years on another property, and plan to take the loss at that point. There are several reasons a taxpayer might choose to defer a loss.
My experience has taught me it normally makes sense to simply take the loss by selling, not implementing a deferral strategy. An example is what we’ve talked about here recently. You own real estate with significant capital gains, and also some with similar capital losses. Don’t fall into the trap of thinking all circumstances with the same facts will work best using the same solutions — it just ain’t so. Sometimes a choice made years earlier can come home to impact today’s decision.
BawldGuy Takeaway: Don’t get lost in the minutia of what to do, when to do it, or how it’s done. For those things, ‘call the guy’. The primary takeaway here is to do whatever you do on Purpose and with a well thought out Plan. The rest will generally take care of itself.
Call me with any questions you may have about your current situation. I can be reached at 619-889-7100 or via email. Have a good one.
Great point. Most people never ever realize that losses can be deferred. And. to be honest with you, it is a rare situation when it actually makes sense to defer a loss. You are also right on point that if you effectuate a 1031 exchange properly, then you are stuck with it. Section 1031 is not elective.
As a tax attorney, I’m “the guy” that they are supposed to call. But, as you know, many people call after the fact. Here is a sad example. A CPA got a new client and was reviewing prior tax returns. During this review, the CPA discovered that the client had deferred a loss through a 1031 exchange in a prior year. The client never even realized it. They came to see me to see if anything could be one. Unfortuantely, I could not help.
I like the moral of your story, call the tax guy before doing anything.
Moore,
Thanks for stopping by. Thanks for your added wisdom as well. That’s why I like inviting Jeff Brown to come do guest posts on Straight Talk. He has good advice!
Tom