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A 1031 tax exchange (also called a 1031 tax deferred exchange) can save you a bundle, but can also be fairly complicated. You can start your education with this article on how 1031 exchanges work. Also check out the page on 1031 property exchange mistakes to avoid.
How a 1031 Exchange
Works
by Michael Southard
A section 1031 tax deferral allows an investor to sell a property, then reinvest the proceeds in a new property and defer all capital gain taxes. Specific conditions for the exchange state that it must be of "like-kind" and must take place within 45 days of the close of the sale. To understand more about how this exchange works, consider the following example:
*If an investor has a $200,000
capital gain and incurs a tax liability of $70,000 in combined
taxes when the property is sold, only $130,000 remains to reinvest
in another property.
*If the investor had, for example, a down payment of 25% and
a loan-to-value ratio of 75%, the seller would only be able to
purchase a $520,000 property.
*If the same investor chose a 1031 exchange, however, and had
the same down payment and loan-to-value ratio as above, the entire
$200,000 of equity could be reinvested in an $800,000 purchase
of real estate.
The exchange offers a powerful protection for investors from capital gain taxes. However, knowledge of what qualifies for a 1031 exchange, and how it works is crucial to receive the full benefits that it can offer. For example, not all real estate qualifies for the exchange. Business property and investment property are the only types that will qualify for the tax deferral.
Both the property sold and received must be of "like-kind", which is often mistaken to mean the exact types of properties. The like kind provision for real property is quite broad, and includes land, rental, and business property. A 1031 exchange may actually be mixed as to type and still be like-kind. For example, you may exchange land for a duplex, or a commercial building for a retail store. The like-kind provision for personal property is more restrictive.
One difficult aspect of making a 1031 exchange is finding a new investment property within the 45 day limit. The IRS is very strict about complying with the restriction and rarely allows extensions. Once a replacement property has been found, the next challenge comes in obtaining the extra capital needed to complete the exchange. Fortunately, there is an easy way to overcome that challenge.
Visit Security National Capital today to learn more about a 1031 exchange.
About the Author
Michael Southard is the Vice President of Security National Capital.
Other pages on 1031 tax deferred exchanges: 1031 Tax Exchange Rules and 1031 property exchange.