Exchange…what the heck? Sounds like a strange notion…exchanging real estate… But this term actually refers to an investor’s ability to ‘exchange’ a property that they sell for a like-kind property. This exchange is possible as a result of Section 1031 of the IRS code. Let’s dig a little deeper for a better understanding.
1031 Exchange: The Basics for Real Estate Investors
If you own investment property and are thinking about selling it and buying another property, you should know about the 1031 tax-deferred exchange. This is a procedure that allows the owner of investment property to sell it and buy like-kind property while deferring capital gains tax.
A 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which allows you to avoid paying capital gains taxes when you sell an investment property and reinvest the proceeds from the sale within certain time limits in a property or properties of like kind and of equal or greater value.
Qualified Intermediaries Facilitate the Exchange
Under section 1031, any proceeds received from the sale of a property remain taxable. For that reason, proceeds from the sale must be transferred to a qualified intermediary, rather than the seller of the property, and the qualified intermediary transfers them to the seller of the replacement property or properties. A qualified intermediary is a person or company that agrees to facilitate the 1031 exchange by holding the funds involved in the transaction until they can be transferred to the seller of the replacement property. The qualified intermediary can have no other formal relationship with the parties exchanging property. Bottom line, if ANY of the proceeds from the sale touch your hands (so to speak), the monies become taxable. You must use a qualified intermediary. Ask us, we know a few.
Why Do An Exchange
The main benefit of carrying out a 1031 exchange rather than simply selling one property and buying another is the tax deferral. A 1031 exchange allows you to defer capital gains tax, thus freeing more capital for investment in the replacement property.
It’s important to keep in mind, though, that a 1031 exchange may require a comparatively high minimum investment and holding time. This makes these transactions more ideal for individuals with a higher net worth. And, due to their complexity, 1031 exchange transactions should be handled by professionals.
Ted Brass is a 1031 Tax Deferred Specialist. Give him a call today so that he can help walk you through the process!