An Overview of 1031 Tax Deferred Exchanges
According to Section 1031 of the Internal Revenue Code, a 1031 tax deferred exchange allows an investor to sell a property, and to reinvest the proceeds in a new property while deferring all capital gain taxes. Section 1031 of the Internal Revenue Code states:
“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.”
Understanding the rules of 1031 tax deferred exchanges will help you to assess your specific needs when it comes to tax exclusion and tax deferral strategies. It’s always a good idea to assemble a qualified team of professionals before making any decisions.
Defining a 1031 Tax Deferred Exchange
With a 1031 exchange, you have the ability to sell one or more of your appreciated assets and defer the capital gain tax payment by acquiring a replacement asset. Usually, this strategy is used in the real estate world with rental and investment properties. It essentially means you’d need to buy a property to replace the one you sold in order to defer the payment for your capital gains taxes.
The 1031 tax deferred exchange allows you to keep 100% of the money or equity from the sale of a property in the form of a new replacement property without forfeiting a large sum to capital gains taxes. Specific requirements must be followed in order to qualify for this exchange.
Requirements to use a 1031 Tax Exchange
With the right structure of the sale of the current asset and the purchase of a new asset, you will be able to meet the requirements of the 1031 tax deferred exchange. You will need a Qualified Intermediary, which is also known as a 1031 Exchange Facilitator or 1031 Exchange Accommodator. This person will help you complete the legal documents necessary to remain in compliance with the rules, regulations and laws.
The Qualified Intermediary must be assigned into the Purchase and Sale Agreement, along with the Escrow Instructions before the close of the sale and purchase transactions. If the Qualified Intermediary isn’t formally assigned to both transactions, you won’t qualify for the 1031 exchange.
In addition to needing a Qualified Intermediary, you must also reinvest or replace the investment values. This must be done by acquiring one or more replacement properties with equal or greater value when comparing the net purchase value to the net sales value of the relinquished property. All of the net cash from the proceeds of the sale has to be reinvested and you will also need to replace any debt you paid off during the sale.
You’re allowed to add more cash into the purchase of the replacement properties, but you are not allowed to use any of the cash for anything other than reinvesting. If you try to use cash out from the sale, you will incur a capital gain income tax or depreciation recapture tax liability.
Along with meeting the requirements of the 1031 deferred exchange, you will need to pay attention to the deadlines! You only have 45 calendar days from the close of the property you’re selling to identify the replacement properties and another 135 calendar days to complete the acquisition of some or all of the replacement properties.
This is just a basic overview of the 1031 tax deferred exchange. It can be a confusing program, but with the help of a knowledgeable professional, you can use 1031 exchanges to defer the payment of capital gains taxes upon the sale of your real estate investments.
Curious to learn more about the possibilities for ideal 1031 investments Western North Carolina? Contact Collin O’Berry of the Altamont Property Group today to discuss your needs. We can be reached at email@example.com or 828-772-1667.