Quit Claim Deeds for 1031 Exchanges?

Question

Hi, All,

Question- can you find another investor with a property similar to yours and do a quit claim deed to each other to restart the clock on depreciation/do an easy 1031 exchange for tax benefits?

Dave Foster · Answer

@Sarah P., @Paul Caputo's right about not resetting depreciation in a traditional 1031 also.  There is one way though to get additional depreciation through a 1031.  As mentioned your basis carries forward into the new property in a 1031.  So imagine a very simplified scenario where you sold a 100K property that was 50% depreciated.  Your adjusted basis after depreciation would be $50K with $50K to depreciate.  If you did a 1031 and bought another $100K property then your basis of $50K in the old property carries forward and you still have $50K to depreciate.

But if you bought a $200K property to complete your 1031 then you carry forward your old basis of $50K and you get the additional basis of the additional purchase.  So your basis in the new property would be $150K.  So you gained another $100K of allowable depreciation.  Your accountant uses the form 8824 to record the impact of the exchange and then sets up the new depreciation tables.

Paul Caputo · Answer

If you want to sell the property and do a 1031 exchange you don't get to reset depreciation, it carries over to the new property so you continue depreciating the new property as if it were the old property. The depreciation only "resets" when you die and leave the property to your heirs - they get a stepped up cost basis and a new depreciation schedule.

The IRS gives some good incentives for the real estate industry, but they generally don't let you have your cake and eat it too. If you're talking about rental property you're depreciating over 27.5 years. If you do a 1031 exchange 10 years after purchase, then you will depreciate the new property over 17.5 years with an adjusted cost basis based on transferring the old property's depreciation schedule to the new property. So a 1031 exchange does not let you "reset" depreciation, rather it lets you buy a new property without resetting your depreciation.

It sounds like you're looking for ways to get more depreciation deductions or avoid the recapture tax. You can't get more depreciation unless you buy more property, but you can front-load some depreciation which results in positive tax benefits through a cost segregation study. If you want to maximize tax deferral you have cost segregation studies done and do 1031 exchanges.

Of course it depends on the size/cost/age of the property if its worth it to do all that.

Dave Foster · Answer

@Sarah P.You can certainly execute a swap that satisfies the requirements of 1031.  However it does not reset the depreciation clock.  Your basis carries into the new property.  And there are numerous pitfalls including valuation differences and paper trail documentation that it's usually not a DIY enterprise. The risk of failure (the tax owed) is generally much much more than the cost of an exchange with A qualified intermediary.

Chris P. · Answer

I understand.  So if I sold a property and purchased another through a 1031 exchange I could still avoid tax breaks from the previous depreciation, but not through a quit claim 1031?

Jim Spatzenfeld · Answer

Much better strategy than 1031 is to just pull out all the cash out of the old property with a cash out refinance and use that cash to buy the next property. Now you get depreciation and interest write offs and still can gain from future appreciation of the old property. Works as long as you still have pos. cash flow on the old property.

Paul Caputo · Answer

Small world thread here @Dave Foster @Sarah P. I used to live in St. Pete and now I'm on the Front Range!

Bill Exeter · Answer

Hi Sarah,

Yes, this is referred to as a two party swap.  The two parties prepare deeds and record concurrently.  The two party swap is usually accompanied by an Exchange Agreement (not be to confused with an 1031 Exchange Agreement for a delayed exchange, but more like a Purchase and Sale Agreement drafted for a concurrent closing).  There are Equity Marketing Groups (A.K.A. Equity Exchange Groups) such as the National Counsel of Exchangors (NCE) that specialize in this type of exchange.

The depreciation clock does not restart because you have deferred your gains, accumulated depreciation, adjusted cost basis, etc.  However, if you acquire a property of greater value and pay cash to equalize the equities (or obtain financing), then you will have acquired additional cost basis that can be depreciated.  Investors often structure a 1031 Exchange to trade up in value when they have a fully depreciated property in order to obtain more (new) depreciation deductions.

Dave Foster · Answer

@Jim Spatzenfeld, You're absolutely right as long as two things are true

1. Your old property is both performing well and can sustain the added debt load of a refinance.

2. The refi will garner enough cash to purchase the new property so it also is in a positive position.

Some times getting rid of an asset is better than holding on to a marginal one.  And accessing 70-75% of the equity of a property each time will tap you pretty quick.  Again that's no problem as long as they're top producers.  But if not  then tapping all the equity through a 1031 is the answer.

Dave Foster · Answer

@Paul Caputo, @Sarah P., I never would have left but couldn't find any water big enough for my sailboat.  I'll be back as soon as Aurora becomes beach front!!

Dave Foster · Answer

And I lived on the Front Range for 20 years also.  We swapped!  Glad it was helpful.

Quit Claim Deeds for 1031 Exchanges?

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