1031 Tax Deferred Exchange
Taxes can certainly be confusing, but knowing what you qualify for can make a huge difference for your bank account—like, for example, a 1031 exchange.
Normally in the sale of real estate, you'd have to pay taxes on the gains from the sale of your property. These gains can be caused by either depreciation deductions taken for tax purposes or the property appreciating in value over time.
A 1031 tax deferred exchange allows you to sell one property, purchase another, and have the gain carried forward.
Eligible Property Types
When you exchange one property for another and defer the payment of state and federal capital gains tax, Section 1031 of the IRS code states that both properties have to be of like kind. Basically, this means that the properties must be held either for investment or for a productive use in a business or trade.
You are not permitted to take bare land and exchange it for a personal residence, because under Section 1031, a personal residence doesn't qualify for tax deferral. On the other hand, you can exchange that same bare land for a rental home. It's also good to note that the properties you're exchanging can be in two different states. If you have questions about what properties would qualify for the type of exchange, you can feel free to call our office. We're happy to help you!
Two Kinds of Exchanges
When you're selling one property and purchasing another, you'll be working with a:
- Simultaneous 1031 Exchange — the exchange happens immediately when selling, then purchasing another property.
- Delayed 1031 Exchange — you'll have 45 days from the sale of one property to find a replacement property, and you'll have 180 days to complete the purchase of the replacement property.
100% Tax Deferral
You must purchase a new property that is of equal or greater value and reinvest all of the net proceeds from the sale in order to enjoy the benefits of 100% tax deferral. Sometimes a portion of the sale would be taxable, though. In the event that you don't obtain an equal or greater amount of debt on the new property purchased, you're considered relieved of debt. According to the terms set forth by the IRS, you'll be receiving a monetary benefit from the exchange. So, the debt relief portion would be taxable, unless you're adding an equal amount of cash to offset this amount.
If you do want to take cash out of the 1031 exchange, you are allowed to do so. Just remember that you'll have to pay taxes on that amount. It is also important to note that when the real estate purchase contract is written, the 1031 exchange must be noted in the contract.
Completing a 1031 Tax Deferred Exchange
Using a Qualified Intermediary, or QI, is required when doing a 1031 Exchange. It can't be someone with whom you've had a prior family or business relationship, so you real estate agent won't be able to fill that role. You must use an independent organization to serve as your QI and answer any questions you have during the exchange. They will prepare the exchange documents and hold the cash proceeds from the sale. If you need any suggestions, let us know!
An additional requirement of a 1031 Exchange is that the person or entity (a trust, LLC, etc.) who holds title on the old property must be the same person or entity who takes title to the new property.
With a 1031 Exchange, you'll enjoy significant tax savings, and it's actually a simple process if you've got a knowledgeable team on your side. When you work with Western Carolina Properties, you'll find an expert in the 1031 Exchange process. We'll be able to explain the contracts, verbiage, and the time constraints involved in order for you to get everything you want from your 1031 Exchange.
Contact us for more information about 1031 Exchanges.