1031 Tax Deferred Exchange

Following is a quick discussion about 1031 Tax Deferred Exchanges.

If contemplating doing a '1031' a experienced tax attorney in 1031 Exchanges should be consulted.

What is a tax-deferred exchange?

A tax-deferred exchange allows a property owner to trade for another similar property or properties without immediately paying federal income taxes on the transaction. Since Section 1031 of the Internal Revenue Code authorizes these transactions, they are also known as 1031 exchanges. Section 1031 states that the IRS will not recognize any gain or loss when parties exchange properties of "like kind" and equal or greater value. Thus, the IRS will not charge any capital gains tax because they do not recognize any gain in the transaction.

What is the benefit of a tax-deferred exchange?

Exchanging one property for another allows a property owner to reinvest more money in a replacement property than using the proceeds from a traditional sale. Owners with highly appreciated property receive the most benefit.

For example, if Jane owns a property worth $1,000,000 with a $200,000 adjusted tax basis, she will pay taxes on $800,000 dollars of gain when she sells it. If the tax rate were 20%, Jane would give $160,000 to the federal government. That would leave $840,000 that Jane could invest in a replacement property.

On the other hand, if Jane exchanged the $1,000,000 property for another property, the IRS would not recognize any gain on the transaction. The IRS would not charge any capital gains tax, and Jane could invest the full $1,000,000 in replacement property.

What is "like kind"?

The investor must sell a property that is being used for income or investment and acquire a replacement property that will also be held for income or investment purposes.

If I have an existing loan on the property, can I still use it for a 1031 Exchange?

Yes! Whether you have a mortgage on the property or own it free and clear, you may sell and exchange for "like-kind".

There are procedures to follow in order to complete a 1031.

Internal Revenue Code 1031:

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."

The sale of the property you wish to exchange must be clearly identified to all parties in the transaction. A 1031 facilitator will be handling the procedure. You will not receive any of the funds of the sale. The funds are held by the exchange service.

After the sale of the exchange property, the investor has 45 days to identify the new property for investment purposes. The investor has 180 days to close on the new property.