1031 Exchange In Real Estate
What Is A 1031 Exchange In Real Estate?
A 1031 like kind exchange refers to the Internal Revenue Code (IRC) 1031 (26 U.S.C. §1031) which allows for the deferral of capital gains when selling and buying like kinds of property. In plain English this means when you sell one type of property and buy another piece of property that is similar in nature you can delay the paying of taxes on the gain from the sale of the first property. So if you are an owner of investment real estate that you want to sell you can delay the paying of taxes based on gains of the real estate by selling the real estate and then buying some other real estate that is similar in nature and whose price is equal to or greater than the property you have just sold.
The real estate you will be selling and purchasing must be held for reasons of investment, production of income or for use in one’s business. Real estate held for recreational purposes, residences (personal use) or any other non-investment purposes do not qualify for use of the 1031 provisions. While IRC 1031 applies to more than just real estate, this article’s focus is on the use of the 1031Exchange and real estate.
Why Use a 1031 Like Kind Exchange
One of the main reasons for doing a 1031 Exchange is for trading up property and not getting stuck with a tax bill that you cannot afford to pay since you are merely upgrading your real estate for business purposes. Common uses include a business who needs to sell their current building and move into a bigger building to accommodate their growth, owners of investment properties who are selling a building in one location to purchase a building in another location. So long as the purchase of the new building is equal to or greater than the sale price of the prior building the owner can delay the payment of taxes on any gains from the sale of the old building by following the rules of the 1031 Exchange.
Requirements of the 1031 Exchange
The main requirements of the 1031 Exchange include a 45 day and 180 day time limit (this time limit could be earlier based on the due date of the tax return) and the use of a Qualified Intermediary to hold profits from the sale. Upon selling the initial property in the exchange you must identify other properties you intend to buy within 45 days. The properties must be identified in writing and signed by the person using the 1031 Exchange. The 1031 document identifying the property must be given to either the sellers of the property or to the Qualified Intermediary within the 45 day period. Giving the 1031 property identification document to anyone else like your attorney, real estate agent, or CPA does not work and will result in your 1031 Exchange being denied and your realized capital gains being presently taxable.
You must purchase the property as part of the exchange within 180 days of closing of the sold property or by the due date (including extensions) of the tax return for the period that covers the sale of the property, whichever date is earlier. Extensions are not available for either of the time limits and missing any of the timeframes will result in your 1031 Exchange being denied by the IRS.
A Qualified Intermediary is used to hold profits from the sale of property for the exchange and is responsible for paying out the money upon purchase of the new property. A Qualified Intermediary is a company that is in the full time business of acting as the facilitator for 1031 exchanges. You can expect to pay fees to a Qualified Intermediary for their services so it is best to check what the fees are and also check how much tax you can save by not paying capital gains through a 1031 Exchange. If the fees that the Qualified Intermediary charge are more than you would pay for taxes on the gain of your property it does not make sense to use a 1031 Exchange with all the time constraints and other rules involved.
Capital Gains Tax Deferral in a 1031 Exchange
In the situation where you purchase a property and still have some cash left over from the sale of your property, that money will be taxed under capital gains tax rules but the rest of the capital gain value that transferred to the new property is not currently taxed. If at a later date you sell the property you purchased as part of the 1031 Exchange then the tax on gains from sale of the earlier property plus any tax on gain from the current property become due when you file your tax returns. As with anything tax and legal related it is highly recommended you consult with tax professionals in order to get the most current advice with your particular situation.
A 1031 Exchange is a valuable tool that allows you to trade up real estate properties without fear of getting hit with capital gains taxes. Whether you are a real estate investor or business person seeking to trade up your properties, when done right a 1031 Exchange can help you accomplish the upgrade and save some tax expense in the year you make the exchange.
1031 Like Kind Exchange at IRS.gov
Qualified Intermediary by Ginny Lacey Gorman
1031 Exchange For Residential Properties by Debbie Drummond
Why I Did Not Use 1031 Exchange For My Rental Properties by InvestFourMore.com
About the author: The above article “What Is A 1031 Exchange In Real Estate” was provided by Paul Sian. Paul can be reached at paul@CinciNKYRealEstate.com or by phone at 513-560-8002. WIf you’re thinking of selling or buying your investment or commercial business property I would love to share my marketing knowledge and expertise to help you. Contact me today!
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