What is a 1031 exchange?
Under section 1031 of the U.S. Internal Revenue Code, a real property owner can sell a property and then reinvest the proceeds in the purchase of a like-kind property and defer capital gains tax. To qualify as a like-kind exchange, the 1031 must be done in accordance with the rules set forth in the tax code and it is best to work with an experienced attorney and a Qualified Intermediary to accomplish the exchange. The 1031 exchange can offer significant tax advantages to real estate investors. There are proposals to eliminate this tax deferred exchange being discussed so NOW may be a great time to invest in a 1031 exchange. Reach out with any questions!
1031 Rules to note:
- The real property you sell and the real property you exchange it for (buy) must both be used for productive use in a trade or business or for investment purposes and must be like-kind. For ex: you cannot exchange a ranch for an airplane.
- The proceeds from the sale must go through the hands of a qualified intermediary and not through the exchangor’s hands or else all the proceeds will become taxable.
- All the cash proceeds from the original sale must be reinvested in the replacement property – any cash proceeds that are retained will be taxable. The replacement property must be subject to an equal level or greater level of debt than the relinquished property or the buyer will either have to pay taxes on the amount of the decrease or have to put in additional cash funds to offset the lower level of debt in the replacement property. The difference in value between a property and the one being exchanged is called boot. If a replacement property is of lesser value than the property sold, the difference (cash boot) is taxable.
Who should consider a 1031 exchange?
If you have real property that will net you a gain upon sale (property that has depreciated for tax purposes and/or has appreciated in fair market value), then you should consider a 1031 exchange.
Section 1031 applies to the property held for productive use in trade or business or an investment property. As an investor, if you want to diversify or expand your assets, invest in a new market, or reset the depreciation clock this is an excellent way of taking advantage of deferred capital gains.
Identification Period: Within 45 days of selling the relinquished property you must identify replacement properties (up to 3 but must close on one of these). This 45 day rule is very strict and is not extended should the 45th day fall on weekend or holiday.
Exchange Period: The replacement property must be received by the taxpayer within the “exchange period,” which ends within the earlier of: 180 days after the date on which the taxpayer transfers the property relinquished, or . . . the due date for the taxpayer tax return for the taxable year in which the transfer of the relinquished property occurs. This 180-day rule is very strict and is not extended if the 180th day should fall on weekend or holiday.
Reverse Exchange: If you acquire the replacement property before selling the property to be exchanged, it is called a reverse exchange. The property must be transferred to a qualified intermediary or similar party and a qualified exchange accommodation agreement must be signed. Within 45 days of acquiring the replacement property, a property for exchange must be identified, and the transaction must be completed within 180 days at which time the property will then be transferred to the exchangor – hence the reverse exchange.
If you are interested in a 1031 exchange or if you are interested in buying, selling, or refinancing please reach out and I would be happy to answer any questions you may have and help you get started! Please contact Katherine Kokkosis at E: firstname.lastname@example.org / T: (212) 471-5100