In the world of real estate, the term 1031 exchange is a type of purchase that is allowed under Section 1031 of the United States Internal Revenue Code. The purchase allows either a business or the owner of an investment property to defer the federal taxes on certain real estate exchanges.
The term comes from the Internal Revenue Code Section 1031 which allows the exchange of real property that is not being held primarily for sale for other business or investment property.
Section 1031 Explained
A 1031 exchange, also known as a like-kind exchange, is one that occurs when one investment property is swapped for another. These transactions are taxable sales but if you meet the requirements of a 1031 exchange you will have limited tax or no tax at the time of the exchange. Essentially you are changing the form of an investment without cashing out or recognizing a capital gain as the Internal Revenue Service would see.
Benefits of a 1031 Tax Exchange
A 1031 tax exchange has many benefits for the average property owner. The primary benefit of a 1031 exchange is that you can sell one property, buy another property and avoid capital gains tax through the transaction. Doing this can save you a substantial amount of money while allowing you to purchase a new property and sell another property. It also helps you to avoid paying what could have been a hefty tax amount.
Time Limits
There are time limits associated with a 1031 exchange that must be strictly adhered to. When completing an exchange a new property must be purchased within 180 days. Failing to stay within this timeframe could have dire consequences. When completing any 1031 exchange you must be sure to complete your new property purchase within the time limit.
Rules for 1031 Tax Exchanges
In addition to the time limits, there are rules associated with 1031 tax exchanges that you should be aware of.
The first and foremost rule is that the replacement property should be of equal or greater value than the original property. You should not get a lower-cost property when doing a 1031 tax exchange.
Second, you can purchase up to three properties without regard to their fair market value as long as their aggregate value does not exceed 200 percent of your original property’s sale price.
Third, you have to identify your replacement properties within 45 days of selling the original property. Finally, the replacement property (or properties) purchase must be completed within 180 days of the initial property sale.
How Can a 1031 Exchange Help With Taxes
A 1031 exchange can help you with taxes by allowing you to avoid short-term capital gains taxes. Capital gains are the profits made from selling an asset such as a car, land, house, or boat. Typically, an individual is taxed on these profits but by completing a 1031 tax exchange you can avoid this tax entirely.
Other Benefits of a 1031 Tax Exchange
There are several benefits associated with a 1031 tax exchange – one being that it resets the clock on depreciation. Depreciation is the percentage of the total cost of an investment property that is then written off each year. It also allows you to consolidate multiple properties into one property for the purpose of estate planning.
Alternatively, it gives you the option of dividing one single property into multiple assets. Perhaps most importantly a 1031 tax exchange allows you to defer the capital gains tax. This frees more capital for investing in the replacement property.
Getting The Most Out Of a 1031 Tax Exchange
There are several benefits associated with a 1031 tax exchange and it is important that you take advantage of as many as possible. Getting the most leverage out of the exchange can help you in the long run with taxes, other purchases, and more.
In order to learn more about this type of tax exchange and find out how they can help you talk to a qualified and experienced tax attorney. The tax attorneys at Wilson Ratledge can review your unique financial situation and determine how a 1031 tax exchange can be used to help you. We can help you in planning your course of action, fill out the documentation for you, communicate on your behalf, and much more.
If you have more questions or are ready to move forward with a 1031 tax exchange, reach out to our office today to schedule a consultation!