OneOne of the most potent tools for deferring and cutting taxes is the IRS Section 1031 exchange.
A 1031 exchange allows anybody with highly-appreciated or depreciated income-producing real estate to exchange their existing property for another like-kind property. The IRS defers payment of capital gains tax until you sell the replacement property, or possibly, for the rest of your life.
Are all exchanges the same?
There are four types of exchange. They include:
Delayed Exchange (sell first and buy the exchange property later)
Simultaneous Exchange
Reverse Exchange (buy the exchange property first and sell later)
Build-to-Suit Exchange
The intent is the same for all; the differences lie in the mechanism.
What is “like-kind”?
Like-kind is a confusing term. It does not mean that you must exchange farmland for farmland, or an apartment block for an apartment block. The definition is broad. It only means that you must swap income-producing property for income-producing property. Whether it is land, residential, or commercial income-producing real estate, it is all classed the same.
Purchases of capital property are wealth-building options. Due to capital gains taxes, some owners may lose some of that wealth when they sell. A 1031 exchange allows investors to save the equity in a tax-deferred exchange. Section 1031 states, “a taxpayer may defer recognition of capital gains and related federal income tax liability on the exchange of certain types of property, a process known as a 1031 exchange.” This means you can defer the payment of capital gains taxes when you sell an investment property and procure “like-kind” real estate as a replacement.
Do I need a 1031 Exchange Facilitator?
For the IRS to accept the exchange, it must be an “arm’s length transaction.” This means that the money from the sale of your property cannot be accessible to you. Trained professional facilitators know all the rules and regulations surrounding 1031 exchanges. They will make sure the IRS accepts your transfer. There are timeliness, conditions, and regulations. Everything requires an expert.
In a delayed exchange, you have 45 days from the closing date of your property sale to identify replacement property(s) for purchase. There are three variations on how you can identify these properties:
(1) The three-property rule
(2) The 200% rule
(3) The 95% rule.
You can choose any of these variations, but all are limited to 45 days for identification of the replacement property(s). After the 45 days. you have another 135 days to close on the replacement property, totaling of 180 days.
There are properties that do not qualify for a 1031 exchange.
~PRINCIPAL RESIDENCE ~ LAND UNDER DEVELOPMENT FOR RESALE ~ CONSTRUCTION OR FIX AND FLIP PROPERTIES FOR RESALE ~ PROPERTY PURCHASED OR HELD FOR RESALE ~ INVENTORY PROPERTY ~ STOCKS, BONDS OR NOTES ~ LLC MEMBERSHIP INTEREST ~PARTNERSHIP INTEREST.