Get a Tax Break
What's a 1031 Exchange?
According to the IRS, it's the exchange of 'like-kind' properties. It was created to give investors incentive to keep investing by giving them a tax break. In short, it allows a person to sell one property and buy a similar property without paying capital gains tax until later.
When the replacement property is finally sold and not replaced, the owner will then have to pay the original deferred capital gains tax plus any additional gain on the sale of the replacement property.
If I still have to pay the capital gains tax eventually, why do a 1031 Exchange?
Good question. There are a few benefits to exchanging properties as opposed to selling them outright.
- By deferring the tax, you have more money to invest in another property (which could earn you more money). In effect, you are getting a tax-free loan out of the government.
- This is one of the few techniques available to postpone or potentially eliminate taxes due on the sale of qualifying properties.
- Any gain from depreciation recapture is postponed.
- You can acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.
What's a 'like-kind' property?The IRS rules are broad on defining a 'like-kind' property. But basically, it is piece of property that is used for business purposes. The property being sold, must be similar in size, value and purpose, as the one being purchased.
Do you need to be a huge investor to get a 1031 Exchange?
Nope. Ordinary people own investment properties or rental homes. Selling one rental home and buying another, constitutes a 'like' property. This means you can do a 1031 exchange and defer taxes.
What are the types of 1031 Exchanges?
There are basically five different types of exchanges.
- A Simultaneous Exchange is when the exchange for the relinquished property and the replacement property occurs at the same time.
- A Delayed Exchange is when there is a time period between the sale of the relinquished property and the purchase of the replacement property. There are there limits as to how long this period can be. This is the most common type of 1031 exchange.
- A Build-to-Suit Exchange is a way to allow the taxpayer to build on to, or make improvements to the replacement property using the proceeds from the exchange.
- A Reverse Exchange is occurs when the replacement property is acquired prior to transferring the relinquished property. These transactions are sometimes referred to as 'parking arrangements'.
- A Personal Property Exchange is when one personal property is exchanged for another personal property.
What's the catch?
There are rules for everything.
