You should be aware of the 1031 tax exchange if you own investment property and are considering selling it and purchasing another. This process allows an investor to sell an investment property and acquire similar property while delaying capital gains tax. In the below text, you’ll discover a quick rundown of the most important aspects of the 1031 exchange—rules, ideas, and terminology to be aware of if you’re considering a section 1031 transaction.
A 1031 exchange is, according to Section 1031 of the United States Internal Revenue Code, which permits you to defer paying capital gains taxes by giving up an investment property and reinvesting the gains within a set time frame in a property or properties of similar kind and value.
Any capital obtained through the sale of a property is still taxed under section 1031. As a result, instead of the seller of the real estate property, the profits of the sale must be transferred to a qualified mediator, who then transfers them to the seller of the replacement property or properties.
A qualified mediator is a person or corporation who agrees to help with a 1031 exchange by keeping the cash until it may be delivered to the seller of the replacement property. There can be no other formal relationship between the qualified intermediary and the parties exchanging property.
1031 Exchange Rules and Timelines
Generally, an exchange is two people exchanging one thing for another. However, the chances of locating someone who has the exact property you want and wants the similar property you have are close to none. Resultantly, the vast majority of trades are prone to be delayed, three-party, or Starker trades (named for the first tax that permitted them).
A competent intermediary (middleman) is required in a delayed exchange, which retains the cash after you “sold” your property and uses it to “purchase” the replacement property for you. This three-party transfer of property is classified as a swap in rules for 1031 exchange.
There are two timing rules which must be kept in close consideration for this exchange. They are as follows:
The first is the identification of substitute property. The money will be sent to the middleman after selling your real estate property. You can’t take the cash since it will be dysfunctional to the 1031 exchange. You must also select the replacement real estate property in writing to the intermediary within 45 days of the sale of your home, describing the property you intend to buy.
According to the IRS, you can choose three properties as long as one of them is finally closed. If they clear specific value standards, you can even select more than three.
In a delayed exchange, the second timing concerns closure. In a period of 180 days after the sale of the old property, you must close on the new property.
The two time periods run parallel, which means you begin counting when your property is sold. For example, if you choose a substitute property 45 days later, you’ll only have 135 days to complete the transaction.