1031 Exchange is a transaction that allows a taxpayer to swap one investment property for another by deferring the capital gains tax. The IRS Code 1031 authorizes the transaction.
You should know about the 1031 tax-delayed exchange if you own an investment property and are thinking about selling it and buying another property. This is a procedure that allows the investment property owner to sell it and purchase like-kind property while deferring tax on capital gains. The name 1031 is taken from Section 1031 of the U.S. Internal Revenue Code which enables you to avoid paying taxes on capital gains when selling an investment property and reinvesting the proceeds from the sale within certain time limits in a similar property or property of equal or greater value.
As an investor, you may consider using a 1031 Exchange for a number of reasons. Some of those reasons include:
1. You may be looking for a property with better prospects for return, or you may want to diversify assets.
2. If you are the owner of investment property, you may be looking for a managed property instead of managing your own.
3. You might want to consolidate multiple properties into one, for example for estate planning purposes, or you might want to divide one property into multiple assets.
Instead of simply selling one property and buying another, the main benefit of carrying out a 1031 exchange is the tax deferment. A 1031 exchange allows you to defer tax on capital gains, thus freeing up more capital for replacement property investment. However, it is important to remember that a 1031 exchange may require a relatively high minimum investment and holding time. This makes these transactions more ideal for higher net worth individuals. And due to their complexity, only professionals should handle 1031 exchange transactions.
1031 exchange rules 2019
1. Like-kind property rule: In order to qualify as a 1031 exchange, the property to be sold and the property to be acquired must be ‘like-kind’. A like-kind property means that both the original and replacement properties must be of the same nature or character or class even if they differ in grade or quality. In terms of real estate, a like-kind property must be an investment property and not a personal one. It is important to note that in order to qualify under section 1031, the original and replacement property must be within the U.S. If you are thinking of a 1031 property exchange the best thing to do is to get the help of a skilled intermediary.
2. Business or investment property only: A 1031 exchange is applicable for business or investment property only and not personal property. In other words, one primary residence cannot be swapped for another. For example, if you moved from California to New Jersey, your primary residence in California could not be exchanged for another primary residence in Moscow. Also, you could not exchange your current primary residence for a vacation property if you were to get married and move into your partner’s home.
3. Greater or equal value rule: To completely avoid paying any tax on the sale of your property, the IRS requires that the net market value and equity of the purchased property be the same as, or greater than, the sold property. If not, you won’t be able to defer 100% of the tax.
4. Must not receive ‘Boot’: For the exchange to be completely tax-free, a taxpayer must not receive "boot." Any boot received is taxable as far as the exchange gain is realized. In other words, you can conduct a partial 1031 exchange in which the new property is of lower value, but it won’t be 100 percent tax-free.
5. Same tax payer rule: This rule requires the taxpayer who owns the relinquished property to be the same taxpayer who owns the substitute property. If the taxpayer changes tax identities, then tax continuity would not exist. For example, if William Smith sells his relinquished property as an individual, the replacement property must also be purchased by William Smith as an individual. Even though it sounds pretty simple, but investors often overlook this important detail.
While the 1031 exchange is
an amazing opportunity, you have to make sure it is the right choice for you
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know how you could benefit from the provisions of 1031 Exchange.