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WHAT IS A 1031 EXCHANGE?
1031 Exchanges
This refers to the Internal Revenue Service code 1031 also called as Like kind
exchange. This code specifies that if an asset usually land or a building (real
estate) is sold and the proceeds of the sale are then invested in a like kind of
an asset then no gain or loss is recognized. For this to be applicable certain
rules must be followed. Broadly these rules are as follows : 1. the asset must
be of like kind 2. the proceeds of the sale must be invested in a like kind
asset within 180 (property must be identified within 45 days) days of the sale
This is an effective way to defer paying taxes that would otherwise have been
due on the first sale for example - you bought a real estate commercial property
say a strip mall for $200,000. After 6 years you sell the property for $250,000.
This results in a gain of $50,000 and you will have to pay capital gains tax on
this amount. However if you invest the $250,000 in another commercial real
estate (like kind - does not have to be a strip mall), then you do not have to
pay any taxes now i.e you defer your taxes till a later date.
A 1031 Exchange is similar to a traditional IRA or 401K retirement plan. When
you sell assets in tax-deferred retirement plans, the capital gains that would
otherwise be taxable are deferred until you begin to cash out of your retirement
plan. The same principal holds true for tax-deferred exchanges or real estate
investments. As long as you continue to re-invest in other real estate, you are
eligible for deferring your capital gains taxes. Unlike the aforementioned
retirement accounts, your rental income on your real estate investments will
continue to be taxed as net income is realized.
Another way to look at 1031 Exchange is as an interest free loan from the
government. The government loans you money to pay for taxes that would otherwise
be due immediately upon sale of your real estate investment. The loan is
interest free and is not due until you “cash out” of your real estate
investments. For certain investors, you may be able to defer your taxes
indefinitely and never repay the loan.
For more information on qualifying for a 1031 Exchange, please contact a
Qualified Intermediary.
How is a 1031 Exchange Accomplished?
Once an investor has decided to pursue a 1031 Exchange, the process is fairly
straightforward and will be carefully facilitated by the Qualified Intermediary.
It is suggested that you contact a QI as soon as the exchange decision has been
made. Here is a typical timeline involving an exchange, presented in the
traditional order of occurrence.
1. Investor decides to sell investment property and do an exchange. Investor
contacts a QI. 2. Investment property is put on the market. 3. Offer to purchase
investment property is accepted. 4. Escrow for the sale is opened and
preliminary title report produced. 5. The QI sends required exchange documents
to escrow closer for signing at property closing. 6. Escrow closes. 7. Within
the first 45 days after the close of escrow on the sale of the relinquished
property, investor identifies replacement property as required by law. 8. Within
180 after the close of escrow on the sale of the relinquished property, investor
closes on replacement property that was identified by them. The exchange is
completed.
Please note: It is my experience that the most difficult component of a 1031
Exchange is identifying replacement property within the first 45 days following
the sale of your relinquished property. The IRS is very strict in not allowing
extensions. The only way to extend your 45 days is on the front end, and that is
done by carefully thinking about your replacement property alternatives before
you close on the sale of your relinquished property.
The source of this article is
Wikipedia, the free encyclopedia. The text of this
article is licensed under the
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