IRS has laid down specific guidelines to be adhered to for successful tax-deferred exchange treatment. To defer all your taxes, your proceeds must be reinvested in a like-kind property of equal or higher value. The identification and acquisition of replacement properties must be completed within specified time frames to qualify for a successful tax-deferred 1031 Exchange.
Let’s understand how a tax-deferred exchange works –
Mark has a $200,000 capital gain and invites a tax liability of around $70,000 in consolidated taxes upon the sale of the property. Only $130,000 remains available to be reinvested. He would be able to acquire a $520,000 new property, assuming a 25% down payment and a 75% loan-to-value ratio,
However, If Mark decides to go for a 1031 tax-deferred exchange, he can reinvest the entire $200,000 of equity in the acquisition of $800,000 in real estate, assuming the same down payment and loan-to-value ratios.
As the preceding example explains, tax-deferred exchanges enable investors to defer capital gain taxes as well as promote meaningful portfolio growth and increases return on investment. The government also encourages tax-deferred exchanges.
Getting a better understanding of a 1031 Exchange
A 1031 tax-deferred exchange allows investors to reinvest the profits from the trade of investment property in one or more replacement properties without inviting immediate federal (and most state) capital gains taxes on the appreciated value. When the sale and purchase fulfill the 1031 exchange standards, taxes are delayed until the newly procured property is sold. This deferral strategy can be duplicated through any number of exchanges until the tax liability crosses into the individual’s estate upon death.
Requirements for a 1031 Tax-Deferred Exchange
Timelines for a 1031 Tax – Deferred Exchange – The exchanger must obey the 45 / 180-day guidelines for an exchange. Once the exchanger sells the relinquished property, they have 45 days to identify the 1031 Exchange property of equal or higher value. Upon identification, the exchanger gets 180 days from the day the property is sold to acquire the designated property.
Like-Kind Property in a 1031 Tax-Deferred Exchange –The investor needs to acquire “like-kind” property. “Like-Kind” property means that it should qualify as a real estate. For example, the exchanger could trade a duplex and buy a commercial property, or they could buy an apartment building after selling a piece of land. The property needs to pass as “like-kind.”
Exchange Property Held for Investment –The relinquished property or the replacement property must be utilized for investment or business purposes. Investors cannot trade primary residence against an investment property, nor can they sell an investment property to purchase a primary home (these will be disqualified for a 1031 exchange).
Equal or Greater Debt and Equity in a 1031 Exchange –If the exchanger sells a property for $1 million, in which $500k was equity, and $500k was debt, then the exchanger must purchase $1 million or more worth of property. Moreover, the exchanger needs to utilize all the equity and reinstate all the debt to delay 100% of the capital gains taxes.
Qualified Intermediary for a 1031 Exchange –The exchanger may not accept cash from the sale. This process is known as “constructive receipt” and would trigger a taxable situation on those monies received. As per the IRS safe harbor requirements, the exchanger must utilize a Qualified Intermediary or QI to assist the 1031 transaction.
The QI is an independent 3rd party (not your agent, broker, attorney or CPA) who retains the sales proceeds and buys the replacement property on your behalf. It is imperative in today’s environment to associate only with reputable, insured and bonded qualified intermediaries.
Engage our services for a profitable 1031 Exchange and defer Capital Gains Tax
1031 Exchange enables your money to churn the maximum profit for you. However, the exchange process is extremely complex in nature, and it would be wise to seek guidance from expert professionals. We have extensive experience in handling highly profitable exchanges for our varied client base.
For consultation and assistance regarding 1031 exchange call – 888-993-2835 or email us at firstname.lastname@example.org