The 1031 Exchange

For investors interested in real estate, there may be no better and worthwhile tool than the 1031 exchange. In short, it is a process through which capital gains tax liability can be completely deferred. Enabling otherwise lost funds to be used for investment. It can be, however, a complex process, requiring due diligence and planning. But most important of all, it requires knowledge of Its Existence!

The logic behind it is simple enough, if you own real estate for business purposes (i.e. not living there) you can transfer all the wealth invested and appreciated in that property to a new one, free of capital gains. It is seen as a “continuation of investment”, you’re not cashing out, merely transferring your wealth to another enterprise. Needless to say, this changes the picture drastically for real estate investment. Where before one would be working with reduced cash, with the help of a 1031 exchange, the entire basis (plus appreciation) can be utilized.

However, the 1031 exchange is not for everyone, certain requirements must be met:

1. The property involved must be of “like kind”. This does not mean property must be in the same asset class, such as land for land, but only that it must be real estate used for business purposes. So it’s perfectly acceptable to trade an oil field for an office building.

2. A Qualified Intermediary (QI) is required. Unless a direct, simultaneous property swap is done, the current investment will have to be liquidated and the proceeds used in the subsequent purchase. But the second that cash touches the investors hands, capital gains tax is incurred, thus a Qualified Intermediary (QI) is required. A QI takes title to the cash and holds it until the replacement property is found.

3. There are time limits. 45 days after the sale of the original property, a replacement property must be identified. 180 days after the sale, the replacement property must be received.

4. It only makes sense if there is appreciated gain on the property. The 1031 exchange only defers capital gains tax, so if there is no gain to tax the 1031 exchange is of no use.

5. The 1031 exchange cannot be used retroactively. If you’ve already sold your property, you cannot use the 1031 exchange.

If these requirements are met, the 1031 exchange can be a great wealth saving & creating tool. Investors would be wise to pay heed to these benefits and contact a QI or tax attorney for a full explanation and evaluation of their situation. It could mean the difference of thousands of dollars.Sphere: Related Content