A 1031 Exchange is the best-kept secret in the tax code. A 1031 exchange allows owners to sell an investment property and buy like-kind property without paying capital gains tax. No other section of the Internal Revenue Code allows owners of capital assets to defer taxes indefinitely.
In simple terms, section 1031 states, “No gain or loss shall be recognized on the exchange of property held for business or investment if such property is exchanged solely for property of like-kind.” If you buy up in value on your next real estate purchase, you will pay no tax. If you buy down in value, there is an opportunity to defer part of the capital gains tax.
THERE ARE MANY ADVANTAGES TO EXCHANGES
- Transfer investment property from one location to another. 1031 exchange investors who move can exchange for properties closer to home. An exchange may also be a way to buy a replacement property in a site ideal for future retirement.
- Improve current cash returns without sacrificing equity. Retirement or other lifestyle changes may cause an investor to search for an investment property that produces a higher income. Exchanging allows investors to swap for a higher income property without incurring any tax liability.
- Gain greater investment appreciation without a large tax bill. Some high-bracket 1031 exchange investors may wish to forego current income to accumulate future equity. Using a tax-deferred exchange makes it possible for investors to “sell high and buy low.” It also allows investors’ profits to continue working for them.
- Diversify or consolidate investments. Changes in an investor’s philosophy may necessitate real estate portfolio changes. Exchanging makes it possible for an investor to sell a group of properties and transfer the equity into one larger property. It is also an excellent tool to redistribute investment risk among a variety of property types and locations.
- Reduce or eliminate management hassles. Exchange an investment property that requires frequent, time-consuming attention for one requiring less hands-on management or professionally managed.
The like-kind provision is quite broad and includes Land, Rental, and Business property. Exchange any of these properties for the other. We have assembled a few tips for a smooth 1031 exchange here.
SOME TIMELINES MUST BE FOLLOWED WITH A 1031 EXCHANGE.
Identification Period: Within 45 days of selling the relinquished property, the taxpayer must identify suitable replacement properties. This 45-day rule is very strict. There are no extensions if the 45th day falls on a Saturday, Sunday, or legal holiday.
Exchange Period: the taxpayer must receive the replacement property within the “exchange period.” This period ends within the earlier of 180 days after the taxpayer transfers the relinquished property or, the due date for the tax return in the year the relinquished property occurs. This 180-day rule is stringent and not extended if the 180th day should fall on a Saturday, Sunday, or legal holiday.
The rules also require that the taxpayer uses a safe harbor to hold the proceeds while the exchange is in progress. The only practical, safe harbor for taxpayers is a Qualified Intermediary (QI). A QI will assist in two major tasks, preparing your exchange agreement and escrowing your equity proceeds during the exchange.
In conclusion, 1031 Exchanges can be a powerful investment tool. With a little planning between your tax advisor and Qualified Intermediary, the client has a great opportunity to save a substantial amount in capital gain taxes. Please feel free to contact us and see if we can help you save with a 1031 exchange.