How to use 1031 exchange?

Website design By BotEap.comA 1031 or tax-deferred exchange allows a property owner to sell one property and then go straight to buying another within a certain period of time. The name comes from the fact that the transaction is an exchange and not just an outright sale. In this process, the taxpayer is eligible for a deferred gain, as the IRS taxes property sales, but not 1031 exchanges. The IRS recognizes a 1031 exchange as a means of deferring taxes on capital gains, so that it is vital that you understand what is involved, what the rules are, and what the underlying intention is before you can even think about doing one.

Website design By BotEap.comAny property owner who is purchasing a replacement “like-in-kind” piece of real estate should consider a 1031 exchange before selling the existing property. The sale of a property would incur a capital gains tax of 15 percent at current rates, but this could go as high as 30 percent if federal and state taxes have been factored in. By doing a 1031 exchange, you can circumnavigate this until such time as your property is sold for cash.

Website design By BotEap.comCapital investment property depreciates at 3 percent per year on the condition that you hold the investment until it is fully depreciated. When you sell the property, the IRS will tax the portion that has been depreciated as income tax.

Website design By BotEap.comThere are two basic rules that must be followed, along with other stipulations set forth by the IRS, for a 1031 exchange. The first rule is that the total price of the replacement “like-kind” real estate must be equal to or greater than the total of the total net sale of the property that was transferred. The second rule is that all of the equity that was acquired as a result of the sale of the relinquished property must be used to acquire the new “like-kind” property. If the value of the acquired property decreases, the tax on the difference will be applied.

Website design By BotEap.comFailure to follow any of these rules will result in tax liability for the person making the 1031 exchange. When the replacement property is of lesser value than the property purchased, the person will incur a tax liability. Also, if not all of the estate is transferred, the “like-kind” property tax rules will also apply. Partial exchanges can also be made, and these are also generally eligible for a partial tax deferral.

Website design By BotEap.comOnly a Qualified Intermediary (QI) can handle the proceeds from the sale of the original property, otherwise all proceeds will be considered taxable. The entire amount acquired at the sale must be invested in the acquisition of the new property, and if any cash is withheld from the proceeds, it will be taxable. It’s also important to note that this doesn’t just apply to cash. Even if you don’t physically receive the cash, but your liability for the acquired property decreases, you will still have to pay taxes.