1031 Exchange: The Best Way to Defer Capital Gains Taxes
Many real estate buyers take advantage of the 1031 Exchange, a real estate investment technique that enables sellers of income property to defer paying capital gains taxes. The following are some of the requirements to qualify for an exchange:
- The Property being sold (relinquished) and the property being purchased (replacement) must be like kind as it relates to the use of properties meaning they must be held for investment or utilized in a trade or business.
- The replacement property must be identified within 45 calendar days from the date the relinquished property is sold. If the 45th day falls on a holiday, that day remains the deadline for the identification of the new properties. No extensions are allowed under any circumstances.
- Up to three potential new properties can be identified without regard to cost. If you wish to identify more than three potential replacements, the IRS limits the total value of all the properties that you are identifying to be less than double the value of the property that you sold. This is known as the 200% rule.
- The closing of one or more of the replacement properties must occur by the 180th day of the closing of the relinquished property. The property being purchased must be one or more of the properties listed on the 45-day identification list. A new property may not be introduced after 45 days. These time frames run concurrently, therefore when the 45 days are up the taxpayer only has 135 days remaining to close. Again, there are no extensions due to title defects or otherwise.
- Sellers cannot touch the money in between the time the relinquished property is sold and the replacement property is purchased. By law the taxpayer must use an independent third party commonly known as an intermediary to handle the exchange. The party who serves in this role cannot be someone with whom the taxpayer has had a family relationship or a business relationship during the preceding two years.
- The taxpayer listed on the relinquished property must be the same taxpayer listed on the replacement property. If an individual, trust or corporation sell the relinquished property than that same individual, trust or corporation must be on title to the replacement property.
- To defer 100% of the tax on the gain of the relinquished property, the replacement property must be of equal or greater value. There are two requirements within this rule. First, the replacement property must be of greater or equal value of the one which is sold. Secondly, all the net cash profits must be reinvested.
- Reverse Exchanges – Title to both properties cannot be in same name at same time
- All previous requirements are applicable and then some. A reverse may come in handy when a seller does not have a buyer for the property they wish to sell and is afraid of losing the new property they wish to acquire. The relinquished property must be sold and closed within 180 days of first acquiring title to the replacement property.
In conclusion, there are countless scenarios involving 1031 exchanges with each one being unique with its own set of facts and circumstances. It is greatly encouraged that you consult a CPA or an attorney who has experience and is knowledgeable with 1031 tax deferred exchanges.