A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
The Combined Rate accounts for the Federal capital gains rate, the 3.8 percent Surtax on capital gains, and the marginal effect of Pease Limitations on itemized deductions, which increases the tax rate by 1.18 percent.
The real estate market in Washington, particularly in areas like Seattle, can be highly competitive and dynamic. This might affect both the pricing and availability of suitable replacement properties within the strict timelines required for a 1031 exchange. Planning and market research become crucial in such environments to ensure you can identify and close on a replacement property within the 180-day window. Overall, while the fundamental process of a 1031 exchange remains the same, Washington does have some local factors that must be considered when planning for a like-kind exchange.
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
Washington is one of the few states that does not have a state income tax. However, it does have a capital gains tax that you might need to consider when selling real estate.
Washington also imposes a Real Estate Excise Tax on the sale of real estate. This tax is applicable to all sales of real estate, including those that are part of a 1031 exchange. The rate can vary depending on the location and the price of the property, and it's something you'll need to factor into your transaction costs. However, the transfer of the relinquished property in a 1031 exchange is generally exempt from REET if the exchange is structured properly and qualifies under the IRS rules.
In Washington, community property law dictates that any assets or property acquired during a marriage are considered community property, meaning both spouses have equal ownership. Separate property, which includes assets owned before marriage or received as gifts or inheritances, remains with the individual unless commingled with community property.
When engaging in a 1031 exchange, it's crucial to consider how community property laws affect ownership and tax treatment. In Washington, both spouses must typically consent to the exchange of community property, and the replacement property acquired in the exchange will also be considered community property.
In Washington, a disregarded entity, such as a single-member LLC, can be used in a 1031 exchange. If the LLC is owned by both spouses as community property, it is treated as a disregarded entity for federal tax purposes, allowing flexibility in titling the replacement property.
According to Rev. Proc. 2002-69, if a qualified entity is treated as a disregarded entity by both spouses, the IRS will accept this treatment for federal tax purposes. This means the entity can sell the relinquished property, and either the entity or the individual spouses can acquire the replacement property.
Divorce can complicate 1031 exchanges involving community property. If a divorce occurs before the exchange is completed, the division of property may affect the exchange's eligibility and tax treatment.
A community property agreement (CPA) can complicate asset division during divorce, as it converts all property into community property. If a CPA is in place, both parties must consent to its revocation, which can impact the exchange process. It's essential to consult with a legal advisor to navigate the division of community property in a divorce to ensure compliance with 1031 exchange requirements.
6,894+ Exchanges (and counting...) — Deferred is redefining how 1031 exchanges should be. Our experienced team delivers a service level that exceeds expectations, with no fee—while earning you interest on your exchange funds.
