A 1031 exchange allows investment property owners to use the proceeds from a sale to purchase similar property and defer capital gains taxes. Rules include identifying the new property within 45 days and closing within 180 days. The definition of “similar” is generous and does not require an exact match.
A 1031 exchange is an excellent tool available to investment real estate owners. Section 1031 of the Internal Revenue Code provides, in effect, that upon the sale of investment property or real property used in a trade or business, the owner may use the proceeds from the property sold to purchase similar or “similar” property. » «Property and therefore will not be liable for capital gains taxes on the income from the initial property. In order to complete a 1031 exchange, there are some basic rules that must be followed.
The “similar” property must be identified within 45 days of the initial property closing. All proceeds from the initial sale must be turned over to a “qualified intermediary” (QI), which is the person or company that essentially performs the role of intermediary. Any income not under QI control is taxable. The QI will hold the funds from the initial property in escrow until closing on the second property. The QI will also help the owner prepare paperwork and other services to ensure the transaction progresses smoothly. Additional 1031 exchange rules require that the new property acquired by the investor have debt equal to or greater than the initial property, and that closing on the second property take place within 180 days of closing on the first property.
In a hypothetical situation where a real estate owner sells a retail store for
$500,000.00 with a net gain of $220,000.00, a substantial capital gains tax would be paid to the IRS. However, if the owner finds a new real estate investment and complies with the 1031 rules described above, he can defer capital gains taxes on that property.
Some people aren’t sure what the term “similar type” means. In short, a similar property has received a very generous interpretation from the IRS. For example, it does not mean that an investor who sells unimproved land must exchange ownership for another piece of unimproved land. Rather, the seller of the unimproved land simply needs to invest in another investment property and follow the 1031 rules while doing so.
Smart Asset.
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