The tax-deferred exchange
Section 1031 is a section of the Internal Revenue Code that allows investors the option of swapping one investment property for another with little or no tax due at the time of the exchange. An investor can essentially change the form of his or her investment without “cashing out” or realizing a taxable capital gain. Exchanges not only protect investors from capital gain taxes, but can facilitate significant portfolio growth and increased return on investment.
There are a few key requirements to the 1031 exchange taxpayers need to be aware of before considering incorporating it into an investment strategy.
1. Must be an investment property
The section 1031 is not for personal use, it is only for investment and business property. The 1031 exchange may apply to a vacation home that is being used as a vacation rental investment property. If your vacation home is not being used as an investment that generates a revenue return, it may not be utilized in a 1031 exchange, as that is considered to be personal real property.
2. Must use a Qualified Intermediary
Also known as an accommodator, a Qualified Intermediary is a company that holds the proceeds of the sale of the exchange property in a trust or escrow account until the purchase of new property takes place.
3. Exchange must be for “like-kind” property
“Like-kind” is actually a very broad term. You can exchange an apartment building for raw land, or a ranch for a strip mall. A client of ours recently exchanged a ranch in Texas for a vacation rental investment property in Fawnskin. Although the rules are surprisingly liberal, it can have negative implications under some circumstances so always consult with a tax attorney or your CPA before executing a 1031 exchange.
4. Timing rules apply
In a tax-deferred exchange, taxpayers typically have 45 days from the sale of the old property to identify potential replacement property and 180 days to purchase the identified property.
5. Always consult with your tax attorney or CPA
This post is for informational purposes only and is not intended to be tax advice. Always consult with a professional tax attorney or CPA before pursuing a 1031 exchange or for any other tax-related issues. Your real estate agent should be comfortable representing you in the purchase and/or sale of properties involved in a 1031 exchange. Don’t hesitate to ask your agent if she has sufficient experience navigating the 1031 exchange with their investor clients. With any investment, knowledge is power, and the section 1031 can be a fantastic tool for the conscientious investor interested in growing his real estate investments while being consulted, supported and represented by qualified professionals.
Contact us today if you would like more information about this lucrative investment strategy.