What is a 1031 exchange? A 1031 exchange is (1) a section of the Internal Revenue Code and Treasury Regulation, (2) a strategy for selling a qualified property and purchasing another property that’s also qualified or considered “like-kind” and (3) a tax deferral or indefinite interest free loan. The transaction described requires strict adherence to rules and regulations including completion within a specific timeline.
A 1031 exchange is an exceptional strategy because the transaction is treated as an exchange and not a sale. The difference between an exchange and selling and buying is that it allows the taxpayer to qualify for a deferred gain.
When to Consider a 1031 exchange?
Taxpayers should consider a 1031 exchange if when selling an investment property the intention is to buy another similar property subsequent to the sale of the existing property. If you do not use the 1031 exchange, you’re liable to pay federal capital gains tax of 15 to 23.8 percent in addition to state and local capital gains tax for real property and 31.8 percent or more for collectibles, such as gold and silver, artwork or vintage cars.
Please note the total price of the replacement property should be equal to or greater than the total sales price of the relinquished property given the goal is to defer 100 percent of the gain. Not all funds received from the sale of the relinquished property need to be spent on acquiring the replacement property. But what is not replaced is taxable. Funds not expended come in two forms, equity or cash and debt not replaced. The first is known as equity boot while the second is mortgage boot; both are taxable.
1031 Tax Deferred Exchange
A transaction can only be considered for deferred tax exchange if it follows US tax code and treasury rules. One of the primary rules is that the properties must be “like kind.” Both properties should also be held for use in a business or as an investment to support the proper intent.
Exchange Rules
Proceeds from the sale have to go through a qualified intermediary. If the sale goes through your hands or your appointed agent, you are likely to pay capital gains tax. The qualified intermediary must be independent from the taxpayer and cannot have acted as an agent for the taxpayer within two years of the 1031 exchange. This includes a CPA, attorney, realtor, or lender. Family and employees are disqualified from being the taxpayer’s qualified intermediary.
Exchange Timelines
Anyone considering an exchange will need to be aware there are two time-lines: the identification period and exchange period.
Identification Period
This is the period during which the seller needs to identify a replacement property he proposes to purchase. The period is 45 calendar days from the time the relinquished property is sold. This period can only be extended for by the IRS in writing or published on their web site.
There are two identification rules. The taxpayer can use either the three property rule where up to three properties can be identified regardless of value, or the two hundred percent rule. Four or more properties can be identified in the two hundred percent rule as long as the total value does not exceed two hundred percent of the relinquished or property sold.
Exchange Period
The exchange period is the time between relinquishing a property and purchasing a replacement. The period is 180 calendar days after the transfer of the property or the due date of the individual’s tax return for that tax year. The exchange period cannot be extended unless the IRS publishes an extension due to a hurricane, flood or natural disaster.
A 1031 exchange is for any US taxpayer, resident or non-resident, individual or corporate who owns property either real or personal used in a business, trade or held for investment. In 2013, the aggregate tax deferral is an estimated $3.7 billion dollars.
Click here to download “Ten Reasons Why a 1031 Exchange Makes Sense.”
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
