What Is a 1031 Exchange?

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What Is a 1031 Exchange?

Post by Admin on Mon May 14, 2018 12:05 pm

If you’re an investor looking to grow your portfolio, 1031 exchanges are something you should know about.

Defined by the IRS

Simply, 1031 is a tax code that allows an investor to defer capital gains taxes by reinvesting the proceeds of one business or investment asset into another. Through 1031 exchanges, an investor can change the form of the investment without cashing out and being stuck with a hefty capital gains tax bill.

The “1031” comes from federal tax code related to the exchange of property held for productive use or investment. It states, “No gain or loss shall be recognized on the exchange or 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.”

The “exchange” part of the term is actually a misnomer. A 1031 transaction is more of a rollover than an exchange, and sellers can rollover gain and postpone taxes an unlimited number of times. There are a few requirements, though.

The Requirements

The property being sold and the new investment property in a 1031 exchange must be like kind. This relates to the use of the property, and it excludes property strictly held for resale. Developers who flip properties won’t qualify under 1031 because their intention is to resell and not invest. Primary residences are also excluded because a 1031 investment isn’t for personal use. Investment properties can always be exchanged for other investment properties, or for vacant land held for investment purposes, however.

There are time limits here to consider. The new investment must be identified within 45 days of the closing sale of the old property according to IRS requirements, and the purchase and closing of one or more of the new properties must occur by the 180th day of the closing of the old property.

In addition, 1031 exchanges require the use of a qualified intermediary by law. An independent third party, or exchange partner, must hold the proceeds of the sale in a separate account until the purchase of a new property is complete.

Investors who want to defer 100% of the capital gains tax need to make sure that the new property is of equal or greater value than the property being sold, and all of the cash profits must be reinvested. The taxpayer listed on the old property must be identical to the one listed on the new property.

In Short

1031 exchanges can protect investors from capital gains taxes and have proven to be a successful way for investors to grow their portfolios and see increased returns on their investments. However, it is important to note that they are complex deals in nature because the tax code has many intricate details. That’s why it’s best to work with a partner who has thorough knowledge of both the exchange process and who knows how to navigate the process seamlessly.

Related Terms:

Term: asset


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