Learning about passive losses and like-kind property exchange isn’t for everyone. But there can be some real benefits once you understand how they can play into your overall tax situation.

A lot of existing information is pretty complicated. What we’re providing here is just a brief overview to get you thinking about your unique situation. But remember that you don’t have to make these decisions alone. We’re here to help!

So, let’s start with some definitions.

Passive Losses

If you’re an investor who doesn’t actively manage your investments — like rental properties or a business in some circumstances — and you suffer a financial tax loss, that’s what’s known as a passive loss.

You can use previous passive losses to offset future passive income. You earn passive income in one of two ways: rentals of real estate and equipment or a business where you don’t “materially participate.” An example would be if you were a limited partner in a business venture.

Non-Taxable Income

If equations are more your speed, here’s a simplified version:

Current passive income + previous passive losses = non-taxable income

Non-taxable income is just what it sounds like: Money the government won’t tax. You can offset your passive income dollar-for-dollar with passive losses to produce non-taxable income. And there’s no limit on how much of your passive income you can offset with passive losses.

Couple of items to note: An investment in the stock market doesn’t always produce passive income, even though you are not actively managing. Passive income is very specific. Also, if you die before claiming a passive carryover loss, you’ll lose that loss.

Like-Kind Property Exchange

If you sell a property and make money on it, those profits can be subject to federal and state taxes. However, you can defer those taxes through a 1031 exchange — better known as a “like-kind exchange.”

So, let’s talk about how that works. A section of the IRS code — 1031 — allows an owner of eligible property to complete a tax-free exchange by purchasing like-kind replacement property with the property sales proceeds.

That kind of transaction allows you to potentially defer up to 100% of the capital gains taxes you’d otherwise owe.

Just like passive income, the rules are very specific:

  • You can’t “touch the money.” It needs to stay with a title company. Otherwise, as soon as you spend or withdraw it, it’s taxable.
  • If you’re doing a like-kind exchange, you have to identify the new property within 45 days and then close on it within six months.

If you have questions about passive losses or like-kind property exchanges, reach out to us.

*Investment advisory services are offered through Avantax Planning Partners℠. Commission-based securities products are offered through Avantax Investment Services℠, Member FINRA, SIPC. Insurance services offered through licensed agents of Avantax Planning Partners. 3200 Olympus Blvd., Suite 100, Dallas, TX 75019. The Avantax entities are independent of and unrelated to CP Financial Services, LLP. Although Avantax does not provide or supervise tax or accounting services, our Financial Professionals may offer these services through their independent outside business. Not all Financial Professionals are licensed to offer all products or services. Financial planning and investment advisory services require separate licenses.

For other helpful audit tools, visit our Resource Center. And let us know if you have any questions.