A 1031 tax exchange is a powerful method for
deferring the tax consequences of the sale of investment property. If
you own rental properties, in particular, a 1031 tax exchange should be
part of your tax strategy.
1031 Tax Exchange
CLICK ME TO GET LINKS
CLICK ME TO GET LINKS
When
a 1031 tax exchange is mentioned, it refers to the 1031 section of the
tax code and the deferment of capital gains taxes. Generally, if you
exchange business or investment property solely for business or
investment property of a like-kind, no gain or loss is recognized. If,
as part of the exchange, you also receive other (not like-kind) property
or money, gain is recognized to the extent of the other property and
money received, but a loss is not recognized. Put another way, it is
best to exchange the property for similar property.
Properties are of like-kind if they are of the same
nature or character, even if they differ in grade or quality. Real
property generally is of like-kind, regardless of whether the properties
are improved or unimproved. The 1031 tax exchange, however, only works
with investment property, not your personal residence. You can use the
revenues from one property to buy multiple properties or vice versa, but
you can’t use the revenues from the sale of rental duplexes to buy a
ranch. It is so technical as to be beyond the scope of a simple one page
article. You should always use a tax professional to assist you in the
exchange.
Unlike traditional real estate
transactions, a 1031 tax exchange requires the use of a third party
known as a qualified intermediary. This person acts somewhat like an
escrow company, but only to the extent of handling the monetary
transactions. When you sell property, the proceeds are transferred
directly to the qualified intermediary who then uses them to make the
new purchase. Any unused funds are subject to capital gains taxes.
As
you might imagine, 1031 tax exchanges have strict time limits. From the
date of sale of your property, you have 45 days to find new properties
and provide written notice to the qualified intermediary. The IRS is a
bear when it comes to this rule, so you must have your ducks in order.
Once you’ve identified the properties, you have 180 days to close from
the date of your original sale. Again, the IRS doesn’t budge an inch on
this deadline.
A 1031 tax exchange is a great way to defer taxes. By
using it, you essentially get to use tax payments to continue to fund
your wealth building activities. That being said, you must be very
organized because the time limits are strictly enforced by the IRS. The
use of a tax professional and real estate attorney are highly advisable.