A 1031 exchange is a tactic commonly used by real estate investors so that they may defer tax liability on the sale of a property. This is done by transferring the rights to a piece of property one would like to sell to an intermediary, who holds the funds gained from the sale of the relinquished property and uses the money to acquire a replacement that fulfills the regulations set out in Section 1031 .
Although the current interest in the 1031 tax exchange could give you the impression that Section 1031 is a recent development, this is untrue. In reality, the 1031’s history stretches all the way back to 1921, although the original concept was significantly different than what we today think of as an exchange. The 1031 Exchange truly came into its own in the ’70s, which saw a host of significant modifications in the manner that exchanges were conducted. These modifications resulted in a more powerful conception of the exchange process and also generated increased interest from real estate investors.
IRC Section 1031 provides for the postponement of paying gains tax if sale proceeds are invested in similar property as part of a qualifying like-kind exchange. Tax sheltered income and long-term growth can be the benefits.
In addition to deferring capital gains tax, other benefits may include:
- Relieve the burden of active real estate ownership and management
- Exchange a non-cash-flow producing property for a cash-flow producer
- Diversify into a portfolio of properties
- Obtain ownership in higher-grade commercial properties
- Facilitate estate planning
There are specific definitions for the types of like-kind property, as well as other items, that can be included and how they are handled from a tax perspective. We’ll help sort these guidelines out in the way that benefits you best.
The capital gains tax deferral an exchange provides to the taxpayer might, at first glance, seem to be a kind of gift from the United States government, however it is, in reality, closer to an interest free loan, because the taxpayer is expected to “repay” the extra funds gained from the capital gains tax deferral by accepting capital gains liability on the subsequent sale of a replacement property. Additionally, this “interest-free loan” is one that may be kept by the investor indefinitely; an investor can choose to make any number of 1031 exchanges before finally sell outright, at which point capital gains taxes must be paid.
What is a 1031 Exchange?
The 1031 exists as a mutually beneficial arrangement between the investor and the United States government, providing a benefit for the country’s economy as well as the individual taxpayer. In looking upon the transfer of money in an exchange as a continuation of an existing investment instead of as a discrete transaction liable to be taxed, taxpayers gain the opportunity to move their money to the best possible investments. This, in turn, helps to elevate the economy by bolstering job growth.
As with anything, Section 1031 has skeptics. Some advocates of change in Section 1031 will pose the argument that the tax free income gained by to the taxpayer in a 1031 creates an unfair advantage. Another common concern is that the strict time limits attached to steps in the exchange procedure could promote a frantic rate of buying, with a resultant increase in asking prices for replacement properties. The aforementioned criticisms, however, are only tenuously linked to reality, and the odds that Section 1031 will go through any noteworthy changes in the coming years are quite low. Looking at the big picture, most will agree that Section 1031 is greatly helpful to all involved, as it allows taxpayers greater profits on the sale of property while additionally encouraging job growth and therefore the greater good of the country. There is no reason to doubt that the 1031 tax exchange is destined to remain a mainstay of the investment world for years to come.
Benefits of a 1031 Exchange
1031 Exchange Services offers a complete line of qualified intermediary services that range from being a safe-harbor for the exchange of funds to complete reporting of the exchange to the IRS (Internal Revenue Service). They provide a range of services like tax-deferred exchange to meet your special needs or those of your client via simultaneous exchanges, delayed exchanges, construction (improvement) exchanges, reverse exchanges, multi-property exchanges, and multi-party exchanges.
Most preferred service is the reverse exchange option. The major reason is that it is capable of solving the issue of finding a way to take control of the replacement property prior to the sale of the old property in a 1031 exchange. The code sees to that it doesn’t allow for an exchanger to exchange into a property already owned. Only reverse exchange is ready to close on a replacement property, while still trying to sell the old property. Other reasons named to setup a reverse exchange include securing the replacement to avoid the risk of possibly losing that property and ridding oneself of the replacement property dilemma and once that old property has been sold, there is a 45 day window to find a suitable replacement property.
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