1031 Exchange

1031 Exchange

  • Michael S. Pruett
  • 03/2/21

What is a 1031 Exchange?

A 1031 exchange, also referred to as a tax deferred exchange is a simple strategy and means for selling one property, that’s qualified, and then proceeding with an purchase of another property (also qualified) inside a specific time frame. The logistics and procedure for selling real estate and then buying another property are practically comparable to any standardized sale and purchasing situation, a “1031 exchange” is different for the reason that entire transaction is treated as being an exchange as opposed to just like a simple sale. It is this difference between “exchanging” rather than buying and selling which, in the end, allows the taxpayer(s) to qualify for a deferred gain treatment. So to say it in simple terms, sales are taxable with the IRS and 1031 exchanges will not be.

Considering the fact that that exchanging, real estate, represents an IRS-recognized technique to the deferral of capital gain taxes, it’s critical to be able to recognize the components involved along with the actual intent underlying this sort of tax deferred transaction. It happens to be inside the Section 1031 of the Internal Revenue Code that individuals can locate the suitable tax code required in an effective exchange. We wish to mention that it really is within the Like-Kind Exchange Regulations, from the US Department of the Treasury, that individuals discover the specific interpretation from the IRS and also the generally accepted standards of practice, rules and compliance for completing an effective qualifying transaction. It is very important to keep in mind the Regulations aren’t only simply the law, but a reflection of the interpretation of the (Section 1031) via the IRS.

Why Tax Deferred Exchange?

Any Real-estate property owner or investor of Real-estate, must evaluate an exchange when he or she needs to secure a replacement “like kind” property subsequent to the sale of his existing investment property. Anything otherwise would warrant the payment of a capital gain tax, which is currently 15%, but could go to 20% in the future years. Also include the government and state tax rates of your given state when conducting a Starker exchange. The main reason for the 1031 would be that the IRS depreciates capital real estate property investments with a 3% per annum rate so long as you keep the investment, until it truly is fully depreciated. Any time you sell the capital asset, the IRS wants to tax you on the depreciated portion as being an income tax, and that could well be on the marginal tax rate. Example, if you happen to hold an investment for Fifteen years, the IRS depreciates it 45%. After that it wants you to pay the taxes on that 45% depreciation. If combined federal and state taxes are 35% at the marginal rate, totaling about 15% of the value of the property (one third of 45%). If your property is fully depreciated, it will become the whole 35% marginal tax rate. An alternate way to ensure it is clear and understandable is when purchasing a replacement property (without having the advantage a 1031 exchange) your buying power is reduced to the point, that it only represents 70-80% of what it did previously (prior to the exchange and payment of taxes). Below is a glance at the basic concept, which can apply to all 1031 exchanges. From the sale of a relinquished real estate property, we must always fully grasp this concept in order that you can easily completely defer the realized capital gain taxes. The 2 major rules which you can follow are:

The total purchase price on the replacement “like kind” property must be equal to, or above the total net sales value of the relinquished, real estate investment, property.

All the money obtained from the sale, of your relinquished real-estate, must be used to buy a new replacement, “like kind” property.

The actual degree in which both of such rules (above) are disregarded will determine the tax liability accumulated for the person executing the exchange. In any event which the replacement property purchase price is less, you will have a tax responsibility incurred. To the extent not all equity is moved from the relinquished to your replacement property, there’ll be tax. This isn’t to state that the (1031) exchange is not going to qualify for these reasons. Always remember, partial exchanges do actually, qualify for a partial tax-deferral treatment. This basically means that the amount, of the difference (if any), is going to be taxed as a boot or “non-like-kind” real-estate property.

A property transaction is able to be entitled to a deferred tax exchange when it follows the 1031 exchange rule laid down in the US tax code plus the treasury regulations.

The foundation of 1031 exchange rule by the IRS would be that the properties active in the transaction have to be “Like Kind” and both properties have to be held for a productive purpose in business or trade, as an investment.

The Section 1031 Exchange exchange rule also sets down a guide for any proceeds of your sale. The proceeds from the sale must proceed through the hands of a “qualified intermediary” (QI) and not by your hands or the hands of one of one’s agents otherwise all the proceeds will become taxable. Your whole cash or monetary proceeds from the initial sale has to be reinvested towards acquiring the new property. Any cash proceeds retained from your sale are taxable.

The second fundamental rule is that the 1031 exchange necessitates that the replacement property must be subject to an equal or greater amount of debt than the property sold or as a result the purchaser will be forced to pay the tax on the amount of decrease. Or else he/she will need to place in extra money to cancel out the low debt amount in the newly acquired property.

There’s 2 timelines that anybody deciding on a 1031 property exchange or (NNN) should stick to and know.

The Identification Period: It’s the crucial period in which the party selling a property must establish other replacement properties which he proposes or wishes to buy. It isn’t uncommon to select more than one property. This period is scheduled as exactly 45 days from the day of selling the relinquished property. This 45 days timeline must be followed under every circumstances and is not extendable whatsoever, whether or not the 45th day falls on a Saturday, Sunday or legal US holiday.

The Exchange Period: This is the period within which a individual that has sold the relinquished property must get the replacement property. It is generally known as the Exchange Period under 1031 exchange (IRS) rule. This period ends at precisely 180 days after the date which whomever transfers the property relinquished or the deadline for that person’s tax return for that taxable year in which the transfer of the relinquished property has occurred, whichever circumstances earlier. Now as per the 1031 exchange (IRS) rule, the 180 day timeline is required to be followed under all circumstances and is not extendable in any situation, whether or not the 180th day falls on a Saturday, Sunday or legal (US) holiday.

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He brings a dedicated, hard work ethic, a strong value of personal relationships, and a skilled yet balanced business background to his Real Estate profession. Michael’s unique skills make him successful in both Residential and Commercial Real Estate.