A 1031 Exchange is a way to defer tax liability on income from the sale of real estate, if you intend to reinvest the income in another real estate purchase within a specified amount of time. The use of the word ‘exchange’ is probably a little confusing, because it’s not a transaction where you trade your property for somebody else’s.
Following the rules and procedures established by the IRS Section 1031 means any gains you make on the sale of the original property are not subject to immediate taxation as capital gains. This is because selling your existing property (known as the “relinquished property”) and acquiring a new property (known as the “replacement property”) is considered an exchange.
You can defer these taxes as long as you continue to exchange every time you sell the property in the future. Specifically, the taxes we are talking about are capital gains tax and “recapture” of any previously taken depreciation.
In order to capture all the tax benefits of your real estate transaction when engaging in an exchange, you need to follow the proper procedure, which includes:
There are other types of exchanges, including reverse exchanges, improvement exchanges, and personal property exchanges. It’s important to work with an experienced QI so the transactions are executed smoothly and you are able to realize all the tax benefits of the transaction.
If you’re selling your property at a loss, a 1031 exchange would not be the right option for you, since there are no profits to protect; but if you are selling your property for a price greater than when you acquired it, a 1031 exchange can save you the tax you would normally have to pay on the gain. This can add up to substantial savings!
Since reinvesting the income you earn on a real estate sale is good for the economy, the government (See IRS Code on 1031 Exchanges) has allowed this tax saving procedure as an incentive for you to reinvest those proceeds immediately.
In order to have a legitimate exchange, the law requires that an independent third party act as the facilitator. Also called a Qualified Intermediary, the facilitator:
Now that you know more about the exchange process, let’s start working. Contact us and we’ll be happy to assist you in every way we can.
Section 1031 of the Internal Revenue Code allows an owner of investment property to exchange property and defer paying federal and state capital gain taxes (up to 15% Federal, 25% depreciation recapture and applicable state taxes) if they purchase a “like-kind” property following the rules and regulations of the Internal Revenue Code. This allows investors to use all the sale proceeds to leverage into more valuable real estate, increase cash flow, diversify into other properties, reduce management or consolidate holdings.
There is some confusion regarding what type of property qualifies for a §1031 tax deferred exchange. The Internal Revenue Code Section 1031 states that “gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” “Like-kind” property can include, but is not limited to, any of the following, provided it is held for investment:
For example, raw land can be exchanged for a single family rental, or apartments or a commercial building. Properties can be exchanged anywhere within the United States.
No, contrary to what some property owners envision, a § 1031 tax deferred exchange is rarely a two-party swap. Most exchanges are delayed exchanges, whereby the Exchanger has 180 days between the sale of the relinquished property and the closing of the replacement property. They must identify the potential replacement property (or properties) within 45 calendar days from closing on the relinquished property.