A 1031 exchange is when a real estate investment property is purchased using the proceeds from another investment property. It allows capital gains taxes to be deferred.
Commonly referred to as tax-deferred exchange and like-kind exchange.
Do I Qualify for a 1031 Exchange?
Under Section 1031 of the Internal Revenue Code, real property owners who sell their property and purchase replacement property that is of like kind and of equal or greater value to the property they sold can defer capital gains tax on the sale.
2022 1031 Exchange Details
The sale of real estate may lead to a significant tax bill, especially if the asset has appreciated greatly or if it has had significant depreciation taken against it.
A 1031 exchange allows you to avoid paying those capital gains taxes when you sell an investment property and reinvest the proceeds from the sale within certain time limits in a property or properties of like kind and equal or greater value.
There are very specific rules that must be followed for a 1031 exchange, including the time frame for when the transaction takes place.
The transaction is the combination of a sale of the original property combined with the acquisition of a new, similar property. However, the transfer of funds and the acquisition must be conducted through a qualified intermediary (the person or institution who holds the funds from the sale of the property and uses them to acquire the new replacement property) for the transactions to qualify under Section 1031.
Essentially, the taxpayer sells the property, but instead of receiving the funds outright, the funds are transferred to the qualified intermediary. The intermediary uses those funds in the purchase of the new property. At no point should the taxpayer have access or control of the funds, as that would cause the 1031 exchange to fail.
Once the sale is made, the taxpayer then has 45 days to identify new property and 180 days to execute the transaction through the intermediary.
Tax can be triggered if the seller receives cash or their debt is reduced as a result of the exchange.
Which kinds of property qualify?
The Tax Cuts and Jobs Act eliminated many classes of property from 1031 exchange, but all real estate investment properties still qualify.
The rules are flexible as to the types of property that can be sold and acquired through a 1031 exchange. You can exchange a single-family rental house for an apartment building, raw land for a restaurant or many other combinations, as long as they are real estate investment properties located in the United States.
You can even exchange multiple properties for one new property or exchange one property for multiple new properties.
A property that has had a 1031 exchange can also have other 1031 exchanges in the future. The gain can keep getting deferred.
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• The seller can defer capital gains tax on the sale of property.
• Tax can be triggered if the seller receives cash (known as “boot”) or debt is reduced as a result of the exchange.
Assumptions When Taking the 1031 Exchange
• The exchange is made with real property that can be sold at a gain.
Requirements to Claim the 1031 Exchange
• The sale and acquisition must be conducted through a qualified intermediary.
• The property must be an investment property.
• The transaction must take place within the required period of time (45 days for new property and 180 days to execute the transaction).
Business Entities That Can Claim the 1031 Exchange
• Schedule C
• Schedule E
• Schedule F
• Farm Rental
• S Corporation
• C Corporation
The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.