Like Kind Exchange
What Is A 1031 Exchange?
A 1031 Exchange also called a Starker or Like-Kind Exchange. A 1031 exchange gives a choice to the taxpayer or an investor by reinvesting the proceeds from the sale of the relinquished property (i.e., the investment property) into qualified replacement property to defer capital gains tax. The net outcome is that the investor or the exchanger can use 100% of the proceeds from the sale to buy another property and defer the capital gains tax.
Properties that are involved in 1031 like kind exchange must be held only for productive use in a business or trade, rental production (i.e., income-producing) or investment purposes.
1031 “Like-Kind” Exchange Explained
It initially started as 1031 Tax Swaps of properties between two parties, often farmers trading parcels of land with each other. In the course of recent years, the regulations regarding 1031 exchanges have become clearer and allow investors to conduct 1031 Exchanges with more guidance. Nowadays, 1031 tax-deferred exchanges are used by both enterprises and individual property owners as part of their investment procedure.
A 1031 Exchange potentially provide real estate investors with greater leverage, improved cash flow, potential property consolidation, increased diversification, and increased potential for geographic relocation. However, there is no assurance that these goals can be met. Similarly to all real estate investments, there is a degree of risk.
The strict identification and timeline rules set by IRS must be followed during a 1031 tax deferred exchange. It can be a powerful wealth-building tool. To guarantee that every requirement of Section 1031 is met, an expert tax advisor should be utilized. The inability to do this can result in associated penalties in addition to immediate tax liabilities.
1031 like kind exchange rules allow investors, in addition to tax deferral, to buy a leveraged replacement property and therefore increase their basis in the amount of additional debt assumed. This can protect as much as 50% to 60% of the rental income cash flow from income taxation. The after-tax return on investment on an yearly basis can be significantly greater because of the possibility of extra return from appreciation of the property.