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 IRS Code allows owners of capital assets to defer taxes indefinitely.
Section 1031 states that business or investment use property can undergo an exchange for like-kind property. In this instance, no gain or loss will be recognized. If you buy up in value on your next property 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 may cause investors to look for investment property with higher income potential. Exchanging allows investors to swap properties 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 demand 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. Investors can replace a high-maintenance property for one that needs less hands-on management.
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 or the tax return due date. The 180 days apply after the taxpayer transfers the relinquished property. The tax return date is the year in which the relinquished property sells. This 180-day rule is stringent. It cannot be extended if the 180th day falls on a Saturday, Sunday, or legal holiday.
The rules also require the taxpayer to use 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. First, they prepare your exchange agreement. Second, they escrow your equity proceeds during the exchange.
In conclusion, 1031 Exchanges can be a powerful investment tool. With a little planning, you have a great opportunity to save a large amount in capital gain taxes. Please feel free to contact us and see if we can help you save with a 1031 exchange.