The 1031 exchange process is fundamentally the same as when the tax deferral was legislated into law in the National Revenue Act of 1921. Historically, the intent was that as long as the taxpayer reinvested the net sales price into replacement property, the capital gains tax that would otherwise be triggered is deferred until the replacement property is sold. Farmers traded land for land, equipment for equipment and horses for horses. Over the years, investors applied the deferral strategy to the sale of real estate. The 1970s Tax Court case of Starker v. Commissioner established that the exchange did not have to be simultaneous or occur in one long closing.
1031 exchange explained
1031 Exchange Examples
Thinking outside the box, a 1031 exchange applies to any property held in the productive use of a trade, business or investment. Property must be real property. 1031 exchange rules must be strictly followed to support the outcome, which is the deferral of federal and state capital gains and depreciation recapture taxes that can amount to over forty percent of the property sales price. The deferral is indefinite and ultimately due unless the property is stepped up to the taxpayer’s heirs upon death. When a replacement property sells, the gain can be deferred again and again in a 1031 exchange. Those otherwise paid out tax dollars represent interest free additional working capital available to taxpayers, both individual and corporate, trusts and limited liability companies subject to federal income taxes.
Real Property
Any real property located in the United States (US) can be exchanged for real property in the US while real property held internationally is eligible for real property held overseas. For example, if the taxpayer is subject to US federal taxation inherits property in India, when sold, the sale may trigger both Indian and US capital gains taxes. A 1031 exchange can defer the US capital gains tax when replacing the real property with another either in India or outside the US.
Examples of Real Property
- Improvements to land already owned by the taxpayer in a leasehold improvement exchange.
- Improvements to replacement property in an improvement exchange.
- Single family residential held as an investment for commercial property.
- Condominium held for investment exchanged for another condominium.
- Timberland for a farm or ranch.
- Subway franchise as lessee, selling their thirty plus year lease interest for real property.
Exchange Strategies
A 1031 exchange is either a forward or reverse exchange. In a forward exchange, the old or relinquished property is sold prior to acquiring the replacement property. In a reverse, the replacement property is acquired before selling the old property. Timing is the critical component when there is more than one property to be sold or purchased. If the taxpayer wants to exchange two relinquished properties into one or more replacement properties, given the two old properties can be sold within forty five calendar days of each other, a forward exchange strategy can be deployed. If the second property cannot be sold in the same forty five day period, then a combination forward/reverse exchange strategy is used to allow a percentage of the replacement property to be acquired by an Exchange Accommodation Titleholder, or EAT. The second relinquished property must be closed within 180 calendar days from the date the replacement property is closed. Upon closing, a deed conveys the interest to the taxpayer.
If the intent when selling real and personal property held in a business or for investment is to replace with like-kind or like-class property, then a 1031 exchange should be considered.
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.
1031 Exchange Overview
Federal and state capital gains taxes are triggered when selling real and personal property held in the productive use of a business or for investment. Even if the asset does not appreciate, there is a depreciation recapture tax of twenty five percent on the aggregate depreciation taken or that could have been taken. The taxes can represent upwards of forty percent of the asset sale. Given the intent is to replace the asset with another, consider initiating a 1031 exchange to use those tax dollars as additional, interest free working capital to acquire the new property rather than paying the taxes.
1031 Exchange Rules Aid Property Acquisition
Understanding the 1031 exchange rules is critical for those in the farming business, own business aircraft, an apartment complex, single family investment, land, or who own in any type of business equipment, the chances are that there will come a point in time when a decision will be made to exchange or upgrade company assets. Business owners and CEOs who find themselves in this position should consider a 1031 exchange instead of a traditional sale the next time they prepare for such an acquisition because under these conditions, they will be able to complete the sale while at the same time, defer the 25 percent recaptured depreciation tax that will have been triggered on the sale. While the idea of such a transaction offers clear benefits, there are certain 1031 exchange rules which must be followed in order to keep the process smooth while keeping it out of the crosshairs of the IRS.
1031 Exchange Explained
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.
1031 Tax Exchange Benefits
The 1031 Tax Exchange is a section in the U.S. Internal Revenue Service Code which allows investors to postpone capital gains taxes during an exchange of like-kind properties for investment or business purposes. Thus, capital gains or taxes are not imposed on a property sold if the net equity plus debt retired is used to buy another property of equal or greater value. Tax payment is deferred until such time that the replacement property is sold without initiating another 1031 exchange.