1031 Tax-Deferred Exchange
Are You A Savvy Investor?
Using a 1031 Exchange
1031 exchange is recognized as a powerful tool for
investors to keep more appreciation in their investment
properties by deferring capital gains taxes. In a
typical real estate transaction, the seller is taxed by
the IRS on any gain realized from the sale. However,
through an IRS Section 1031 Exchange, the tax on the
gain is deferred until some future date, allowing the
investor to keep all of his money working for him.
theory behind Section 1031 is that when a property owner
has reinvested the sale proceeds into another property,
the economic gain has not been realized in a way that
generates funds to pay any tax. In other words, the
taxpayer's investment is still the same, only the real
estate has changed (e.g. one property for another).
Therefore, it would be unfair to force the taxpayer to
pay tax on a "paper" gain.
like-kind exchange under Section 1031 is tax-deferred,
not tax-free. When the replacement property is
ultimately sold (not as part of another exchange), the
original deferred gain, plus any additional gain
realized since the purchase of the replacement property,
is subject to tax.
a few simple rules must be followed in order to qualify
a real estate transaction as a 1031 exchange. The
question and answers below are provided to help you
understand this benefit.
What are the tax advantages in a 1031 exchange?
can defer the payment of capital gains taxes associated
with a real estate transaction. By selling one property
and buying a higher-priced property, you 'roll' one
property into another and no capital gains taxes are due
at the end of the year.
only real estate property held for business or
investment purposes can be used in a 1031 exchange, and
both properties in the transaction must be of "like
What is meant by "like-kind" property in a 1031 exchange?
Like-Kind refers to the type of property being
exchanged. You can exchange any real estate investment
for any other type of real estate investment -- for
example, vacant land can be exchanged for rental
Are their time restrictions on a 1031 exchange transaction?
1031 Exchange, you are required to "identify and
designate" your new property on or before 45 days from
the transfer of your old property and Closing must occur
within 180 days of the closing of your old property, or
before the due date for filing of your tax return for
the year in which the old property closed, whichever is
earlier. You can always get the full 180 days to
complete your Delayed Exchange if you timely request an
extension for filing your tax return. While the 45 day
identification period may seem short, you should
remember that your search will typically begin from the
date you current property goes under contract which
should provide you with ample time to identify a
Can I sell or buy multiple properties in a 1031 exchange?
you can exchange multiple smaller properties for a
larger one and vice versa. The key is always trade up in
value in order to maximize the amount of capital gains
taxes that are deferred.
How can I defer the maximum amount of capital gains tax in a 1031 exchange?
main rule is that the replacement property being
purchased must be equal or greater in value to the
relinquished property being sold. The net effect must be
that the entire net proceeds from the sale must be used
to purchase the replacement property.
Does one receive cost basis for the replacement property?
cost basis from the relinquished property is carried
forward to the replacement property in a 1031 exchange.
What is a Qualified Intermediary and must I use one in a 1031 exchange?
Qualified Intermediary (QI), also called an accomodator
or facilitator, is a third-party that facilitates the
transaction and is required by the IRS to qualify a 1031
tax exchange. The IRS does not allow your accountant,
attorney, or escrow company to act as the QI.
Can I do multiple 1031 exchanges and avoid paying taxes altogether?
by continuing to sell and buy like-kind properties and
following 1031 exchange rules, your estate when you die
can avoid paying capital gains taxes.
Can I buy a property before I sell one and still qualify for an exchange?
Reverse Exchanges were given belated IRS blessing nearly
13 years after issuance of the Deferred Exchange
Regulations. Revenue Procedure 2000-37 effective
September 15, 2000 sets out Safe Harbor Rules for a
Reverse Exchange, the Facilitator Company will be
required to take title to property to make the exchange
work. The Facilitator Company essentially "warehouses"
property until the Relinquished Property sale can close
with a "real buyer". The Facilitator Company will be
taking title to property to accomplish the Reverse
Does it cost any more to do a 1031 Exchange vs a normal buy-sell?
Because you have added another party into the transaction, you will have some additional cost in the transaction. The QI will have a fee for their services and typically, the closing attorney fees will be increased somewhat.
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