A 1031 exchange is a common way for real estate investors to defer paying taxes on the sale of an investment property. It’s also known as a like-kind exchange or a tax-deferred exchange. Basically, if you sell a property and reinvest the sale proceeds into another qualifying property, you can defer your capital gains taxes until you sell the replacement property.
What Does “1031 Exchange” Mean?
The name “1031 exchange” comes from a section in the Internal Revenue Code, and it has some specific rules you need to follow. The properties being exchanged have to be considered “like-kind,” meaning they are both held for investment or business purposes and are similar in nature or character.
What is the Timeline for a 1031 Exchange?
The process starts by identifying a replacement property within 45 days of selling the original property. Then, you have 180 days from the sale to complete the exchange by closing on the replacement property.
During this time, the sale proceeds are held by a qualified intermediary, who is a third party that helps facilitate the transaction and ensures the funds are reinvested into the replacement property.
What Are the Benefits of a 1031 Exchange?
The benefits of a 1031 exchange are pretty impressive and enable investors to leverage their capital to go even further by allowing them to defer taxes on the sale of a property. This means more money can be used to put into future investments, helping with diversification and growth. The capital gains taxes are deferred until you sell the final investment property so in theory, you can continue to “trade-up” indefinitely.
It’s important to note that any cash or other property received by the property owner during the exchange is considered “boot” and is subject to taxation. The replacement property must also be of equal or greater value than the original property.
The rules for a 1031 exchange can be a bit tricky, so it’s best to work with a qualified intermediary and get advice from a tax professional to make sure everything goes smoothly. If you are interested in learning more about 1031 exchanges and investing in real estate, contact us today to be connected with a qualified and experienced agent in your area or visit irs.gov for more information.