1031 Exchange
What is a 1031 exchange?
One can exchange any investment property for another like kind investment property of equal, greater, or lesser value. There are no tax consequences at the time of the exchange if the exchange is of equal or greater value. Your primary home is not eligible, but most other properties would qualify as an investment property. If you sell without making an exchange, you must pay a 25% recapture tax on you depreciated property. Long term capital gains are taxed at 20%. Gains from the sale of property held less than 18 months are taxed at 28%.
Do I qualify for a 1031?
Investment property sold in any state can be designated as a 1031 tax exchange candidate in the sales contract. This must be stated in the initial sales contract. Any investment property can then be used as a tax deferred exchange vehicle to buy investment property. It does not matter who purchases your property or what they intend to do with it. You must, however, decide what property is to be exchanged within 45 days after you sign the sales contract. The entire transaction must be completed within 180 days. Funds must be held in an escrow account with an exchange agent until the sale is completed.
How can I assist you with a 1031?
If you have investment property that you would like to sell but do not want immediate tax consequences, Draper Realty can help you do a tax deferred exchange. Our goal would be to provide a quality real estate investment in a prime mountain area that will not only defer taxes at the time of the sale, but protect the principal and produce the highest possible return. Draper’s job is to locate property that fits the investment goal and guide you in making the transaction. As we are not accountants nor lawyers, Draper Realty recommend that you consult either or both with questions that may require their expertise.
Section 1031 of the U.S. Internal Revenue Code allows investors to defer capital gains taxes on the exchange of like-kind properties. 1031, or tax-deferred, exchanges hold great advantages for all parties.
Tax-deferred exchanges allow a taxpayer to sell a piece of property and purchase a replacement property without incurring any tax liability. By structuring the transaction according to U.S. Treasury regulations, the exchange allows a taxpayer to realize zero capital gain in the sale and replacement purchase.
The tax-deferred exchange is a great vehicle in the situation described above–when a property owner wants to sell a property in one location and buy in another. It also presents a great opportunity for a party to increase cash flow. A party with vacant land, for example, may be able to use a 1031 exchange to replace vacant land for improved income-generating rental property. The 1031 exchange allows a party to diversify or consolidate real estate investments. If, for example, one has several rental houses and wants to exchange them for an apartment building, the 1031 could allow for that. Or if one wants to sell an apartment building and buy several rental homes, the transaction could satisfy the standards of a 1031 exchange.
What are the basic requirements for an exchange to qualify for 1031 status?
1. The property exchanged must be of like-kind. Many people misunderstand this provision, thinking it must be a direct swap. But the requirements are a little more generous. It is possible, for example, to exchange a vacant piece of land for an improved piece and still meet the requirements for like-kind property.
2. The property must be held for productive use in trade, business or investing. Examples of such property include a strip mall, warehouse, residential rental property or land held for speculative investment. This does not include personal residences; there are other provisions in the tax code that cover the taxes on the sale of a personal residence. Nor does this requirement include land that a developer holds in inventory to sell later.
What types of exchanges are there?
1. Two-party exchange - buyer and seller swap like-kind properties without being taxed for a gain or appreciation. Because it is difficult to find a buyer and seller willing to simply trade property, the tax code allows for other exchanges.
2. Three-party exchange - buyer will buy a client’s property, referred to as the relinquished property. A seller will sell the replacement property to a client by passing title through the buyer. This, too, is a rare type of 1031 exchange, because the buyer and seller often do not want to be involved in facilitating the exchange in such a way.
3. Deferred exchange - the most common exchange, includes using an intermediary, someone who will close the sale of a client’s relinquished property to the buyer and close the purchase of the replacement property by a client. The tax code defines who can serve as an intermediary. Title insurers or bank trust departments, for example, may meet the criteria to serve as intermediaries; family members or corporations of the parties involved may not. Lawyers or accountants should be utilized to assist with structuring the 1031 exchange.
What are the steps to a deferred exchange transaction?
A client, the taxpayer, sells the property to the buyer under a contract between the two that is assigned to an intermediary. This sale closes just like any other real estate sale, and the intermediary holds the sale proceeds. To meet the 1031 standards to defer the tax, the taxpayer must identify a replacement property within 45 days of the sale of his own property. Within 180 days of closing the first part of the transaction, the taxpayer must close the sale on the replacement property to meet the requirements of a tax-deferred exchange.
A taxpayer who receives cash in the 1031 transaction, is relieved from debt or has a lower mortgage after the transaction is over, will realize a taxable gain to that extent. There may, however, be steps he or she can take before listing the property for sale that could decrease the potential tax liability.
To effect a 1031 deferred exchange, the contract for the sale of your property should contain a clause allowing for the contract’s assignment to an intermediary. Such a clause should also require the buyer to cooperate in a 1031 exchange. Similarly, the contract for the purchase of replacement property should require the seller to allow a client to assign the contract to an intermediary and to cooperate in the 1031 exchange.
How do I get started?
A 1031 exchange can benefit you by allowing income tax deference, providing substantial short-term savings. Contact me to see if you qualify. We’ve done a lot of these up here!
related links:
QUESTION!
IF I SELL AN APARTMENT BUILDING WITH AN INCOME F $2,000 MONTHLY DO I HAVE TO EXCHANGE (1031) FOR A PROPERTY WITH THE SAME OR GREATER INCOME?
Hello Grace,
A 1031 Exchange requires the property you are purchasing to be at least equal or greater value to the property you are selling. This can be multiple properties or a single property. The income produced by the properties does not factor in with a 1031 Exchange.