A 1031 exchange allows an individual to sell investment assets and reinvest the proceeds in a similar type of investment, thereby bypassing the capital gains tax that would normally need to be paid. It is essentially a swap of one investment property for another, deriving its name from Section 1031 of the Internal Revenue Code. There are certain advantages to using these exchanges, but they can be complicated. Understanding the proper way to use them can help you save money and avoid tax problems. Let the Tax Law attorneys of SederLaw guide you.
Here are some of the most frequently asked questions about 1031 exchanges:
What is a 1031 exchange?
If you own investment assets that you are thinking about selling so you can re-invest, you may be able to use a 1031 exchange to do so. Using this procedure, you can sell the investment and purchase like-kind property. In doing this, you can defer the capital gains tax you would otherwise have to pay. Think of it as exchanging one investment property for another while deferring the capital gains tax.
What is like-kind property?
Most 1031 exchanges must be for what is known as “like-kind” property, a rather broad term that refers to properties of a similar nature (not necessarily quality). A vacant strip of land can be exchanged for a building, or a residential property swapped for industrial property. The common thread here is that each of these involves real estate or land use. “Like-kind” would not cover exchanging any of the above-mentioned pieces of land for art collectibles.
Are there other restrictions on the property that can be exchanged?
While residential property may qualify for a 1031 exchange, it (or any other property) must be held for investment or business purposes. The property that is purchased in the exchange therefore cannot be for personal use. The property must also be physically located in the United States. In addition, certain types of assets are excluded by definition. Those include:
- Certificates of trust
- Partnership interests
Why might I consider a 1031 exchange?
You may wish to use a 1031 exchange for the following reasons:
- Diversify your investment assets
- Obtain property with better returns
- Obtain managed property (rather than managing it yourself)
- Increased cash flow and income
- Consolidate multiple properties into one
- Acquire property in a better market somewhere else in the country
- Free capital for investment that would otherwise be paid in taxes
What timeframes may affect a 1031 exchange?
There are two main timeframes you need to be aware of: the 45-day rule and 180-day rule.
45-day rule. Many exchanges involve a third party, known as an intermediary, who holds the money from the sale of the original property and then uses it to purchase the replacement property. When you sell your investment property, the intermediary will need to hold the cash proceeds. Within 45 days of the sale, you must notify the intermediary in writing of the specific piece of replacement property you wish to purchase. There are several ways to identify property to meet this 45 day requirement.
180-day rule. You must close on the replacement property within 180 days of selling your original property. The 45 days and 180 days run concurrently, so time is of the essence to complete the exchange.
While the benefits of a 1031 exchange are potentially significant, there are numerous rules – in addition to these – of which you must be aware. Contact SederLaw’s Tax attorneys. We can explain the advantages of 1031 exchanges, along with the regulations that govern them. If a 1031 exchange is right for you we can counsel you through the entire process from start to finish.
Reach out to us today to get started.