1031 Tax Exchange

1031 Tax Exchange

A 1031 tax exchange is an exchange in which capital gains tax deferral is possible to real estate owners who sell their investment, rental, business or vacation real estate, and reinvest the net proceeds in other real estate. Real Estate held for these purposes are called 1031 properties. Sometimes they are called like kind sales.

1031 Real Estate Tax Exchange

The sale of the sold property and the acquisition of the replacement property do not have to be simultaneous. A non-simultaneous exchange is sometimes called a Starker Tax Deferred Exchange. Property owners may sell 1031 properties and defer taxes on the sale's profits by meeting the requirements of Internal Revenue Code known as the 1031 exchange. The purpose of the 1031 Exchange or like kind exchange is to allow sellers of like kind property to buy replacement property within a specific time period and defer taxes.

Sellers have a maximum of 180 calendar days from the closing of the initial sale to complete the 1031 exchange. Within the first 45 days of this period a seller must designate candidate properties and properly identify them to the IRS. A seller may target up to 3 properties regardless of value or a group of properties with a combined value that does not exceed 200 percent of the value of the initial property sale. The funds in a trust account can be used as earnest money for designated property once all IRS requirements for a 1031 exchange are met.

If no new properties are identified in the first 45 days or no designated transaction is completed during the full 180 day period, the trust will be liquidated and the sale proceeds will be taxed at the prevailing capital gains rate.

Section 1031 is most often used in connection with sales of "real property". Some exchanges of personal property can qualify under Section 1031. Exchanges of shares of corporate stock in different companies will not qualify. Also not qualifying are exchanges of partnership interests in different partnerships and exchanges of livestock of different sexes.

Sell your current investment property

It is important to state that you will be engaging in a 1031 exchange in the sales contract before you close. You must have a "Qualified Intermediary" receive the net proceeds at close and hold the money until you close on the new investment property. If you do end up closing on the property without doing both items, you will not be able to do a 1031 exchange.

Identify the Replacement Property

Section 1031 of the IRS code requires that you identify the new replacement property within forty five days following the sale of the relinquished property. As a general rule of thumb, you may identify up to three properties as potential replacement properties. However, it is possible to identify additional properties, subject to certain restrictions. It is important to remember that the IRS had considered tenant in common property to be vailid replacement property for the last few years. You may want to review multiple tenant in common properties if only to identify as "back up properties" if for whatever reason your top choice does not close. Not identifying multiple replacement properties is one of the most common reason an exchange will not be allowed and you are then forced to pay taxes.

Purchase the replacement property

You must obtain the replacement property within 180 days following the sale of the relinquished property. The Qualified Intermediary pays the closing costs and you receive the deed to the replacement property. One stipulation for deferring your taxes with an exchange is that, among other things, the replacement property must be of equal or greater value to the relinquished property. Remember that if you are using a tenants in common property as a replacement property, make sure you are working with someone that specializes in tenant in common property. A TIC property is one with multiple investors that is normally managed by a professional property managament agency.

You will want to work with 1031 exchange professionals to ensure compliance with the specific regulations as defined by the IRS. An expert can offer you a more comprehensive and strategic tax exchange, which follows due diligence.

With the increase in tenant in common property deals in recent years and the amount of cash driving the real estate marketplace, deferment of taxes has become an essential tool for today’s real estate investor. Only a few years ago, real estate exchanges were a foreign term for many investors, but today it is commonplace in real estate transactions, and an ideal solution for defering those capital gains taxes.

1031 Tax Exchange

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