Are you an investment property owner? If yes, you must be aware of the major tax liability you would have to adhere to in case you decide to sell the property. However, with a 1031 exchange, you can defer this tax liability indefinitely, given you meet all the requirements in time.
Want to know more about a 1031 exchange? Read on to explore how like-kind exchanges can help you defer the capital gains taxes on your investment property sales proceeds.
Understanding 1031 Exchange
A 1031 exchange, also known as a like-kind exchange, is a 100-year-old tax saving tool that derived its meaning from Section 1031 of the US Internal Revenue Code (IRC).
Section 1031 of the IRC clearly states that a taxpayer can defer the taxes on capital gains taxes if they sell an investment property and reinvest the sales proceeds in a like-kind, eligible replacement property during a specific time frame.
If we get into the specifics, the term “like-kind” means the relinquished property (the asset you are selling) and the replacement property (the asset you plan on buying using the sales proceeds) must be like-kind investment properties. In short, you can only exchange a property that is being held for investment purposes for use in business or trade.
Considering 1031 Exchange Implications
When buying or selling an investment property, tax implications are a major consideration. However, you can use tax tools like a 1031 exchange to avoid some major tax implications with real estate investments.
It’s true that capital gains taxes can not entirely be avoided with a 1031 exchange. However, you can defer them indefinitely, helping you build wealth. In short, 1031 exchanges should always be a part of the discussion when selling or buying an investment property.
The benefits of a 1031 exchange are straightforward to understand, but the rule complications can take a toll on your mind. Therefore, it is vital to connect with a registered investment advisor before you proceed with the process. In addition to finding the right replacement property, you must also adhere to the time limitations. A failed 1031 exchange would mean triggering your tax penalties, which would include paying the taxes you wanted to defer, plus the interests and fines.
Apart from tax deferring, a 1031 exchange can also come with benefits like better business strategy protection, leveraging into a new property, optimized cash flow and investment portfolio diversification.
Why Do A 1031 Exchange?
You can leverage the following benefits from a 1031 exchange:
- You can defer the taxes on capital gains and depreciation recapture.
- The property you sell can fully be depreciated.
- The property value can get the full appreciation.
- Investors can leverage into new properties and increase their cash flow.
- You can step out of managing multiple properties through consolidation.
How To Ensure A Successful 1031 Exchange?
For starters, you must connect with a registered investment advisor to start your property search and a QI who will impound your sales proceeds until you are ready to reinvest.
In addition to this, here are some things to remember:
- The taxpayer’s name must remain the same throughout the process.
- You must complete the exchange within 180 days of relinquishing the property.
- You must seek the help of a QI (Qualified Intermediary).
- You must follow the property identification keywords.
Regarding the property identification rules, you must follow any ONE of the following identification processes to identify your replacement properties:
- You identify up to three replacement properties within the 45-day ID period.
- You identify more than three replacement properties with a combined market value lower or equal to 200% of the fair market value of the relinquished property.
- You identify more than three replacement properties with a combined market value equal to or less than 200% of the relinquished property, with an intent to acquire 95% of the combined market value of the properties you identified.
Get Expert Help For A Simple 1031 Exchange
1031 exchange may seem complicated, but with the right team of people working with you, you can successfully defer the taxes and reinvest into more promising properties. Using our experience and knowledge, we help you find the right replacement property before your 45-day ID period ends. Reach out to us to get your customized property list.
