A 1031 exchange is a wealth building strategy known as Internal Revenue Code Section 1.1031. It is used by corporations, individuals, trusts and partnerships both domestic and foreign, for the exchange of real and personal property held in the productive use of a business or for investment. With each 1031 exchange is a timeline requiring strict adherence.
1031 Exchange Wealth Building Strategy
There are many reasons to initiate a 1031 exchange. One of the core reasons is the tax deferral of the federal and state capital gains and recaptured depreciation taxes given replacement property of equal or greater value is acquired within the exchange timeline. The tax deferral represents an indefinite interest free loan. When the replacement property is sold and another 1031 exchange is not initiated, the deferred gain on the original property is due along with any gain since the replacement property was acquired. The 1031 exchange allows the taxpayer, rather than paying the tax to use those dollars towards replacement property that may generate additional cash flow, or have greater depreciation, be in a better location or no longer require as much labor to maintain.
1031 Exchange Timeline
Every 1031 exchange has an identification period and an exchange period. When the taxpayer transfers the relinquished property, the identification period begins, ending at 11:59 PM on the 45th calendar day. Beginning on the same day as the identification period, the exchange period ends no later than the 180th calendar day. The timeline starts the day following the transfer and not on the closing day, allowing a full 45 and 180 days post-closing. After October 17th, to receive the full 180 calendar days, an extension for filing federal income tax returns is required; otherwise the exchange ends on the due date of the tax return.
Identification Period
By the end of the identification period, the potential replacement properties must be unambiguously identified generally to the qualified intermediary. The property or properties do not need to be under contract. A form is typically provided by the intermediary to complete the identification requirement. The replacement property can be acquired before the end of the identification period. If the replacement property is of equal or greater value than the old or relinquished property, there is no need to identify the property. Without an identification form received by 11:59 PM on the 45th calendar day, the exchange ends and the remaining funds are forwarded to the taxpayer.
In the case where the exchange started on or after October 17th, the balance of exchange proceeds are received in the next year. Those funds will be taxable in the following year under the installment sale reporting rules.
Replacement property title must be conveyed to the taxpayer by the 180th calendar day post-closing. The only extensions are those that are found in writing on the Internal Revenue Service website. Presidentially declared disasters, terroristic or military action or taxpayers serving in combat zones extend the 1031 exchange timeline.
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