Exchanges Allow You to Delay Capital Gains Taxes
Capital gains taxes are deferred if all of the exchange funds are
used to purchase like-kind investment property.
The deferment is like getting an interest-free loan on the tax dollars you would have
owed for a cash sale. More equity is retained, and that helps you move into properties
of higher value each time you perform a 1031 exchange.
What's Eligible?
A 1031 exchange is possible when you sell real estate held for investment purposes.
It cannot be used for the sale of your personal residence.
Like Kind Properties
Exchanged properties must be like kind. For a real estate exchange this means real-property
for real-property, but not necessarily land for land or a rental house for another rental house.
Take a look at the IRS rules for specific information about what types of properties qualify as
like kind.
You can exchange a single property for multiple properties, or purchase one property from
the proceeds of several. Proceeds not used to purchase new investment property are taxed
as a cash sale.
"In a like-kind exchange, both the property you give up and the property you receive
must be held by you for investment or for productive use in your trade or
business." -IRS
Exchange Basics
Before you put the property under contract, find someone to act as a qualified intermediary,
also called a facilitator or accommodator. This person or entity is a neutral party that takes
possession of the proceeds from the sale of your property, uses the funds to purchase the new
property, then transfers title of the property to you.
"A qualified intermediary is a person who enters into a written exchange agreement with you
to acquire and transfer the property you give up and to acquire the replacement property and
transfer it to you. This agreement must expressly limit your rights to receive, pledge, borrow,
or otherwise obtain the benefits of money or other property held by the qualified
intermediary." -IRS
The Wording is Critical
Your contract to sell or purchase real estate must contain wording that shows an intent to
perform a 1031 exchange.
A real estate attorney or your qualified intermediary can help you with the wording.
You (or your agent) should send the intermediary a copy of the sales contract and any other
information they require.
Identifying the Replacement Property
If you haven't already done so, identify replacement property. You have 45 days from closing
on the relinquished real estate, the property you are selling, to identify up to three
replacements. Your list must be sent to the intermediary in writing. The IRS offers no
flexibility on this time period.
Closing Dates Are Important
The closing date for the new property must take place within 180 days of the closing on
the relinquished property.
Keep In Touch with All Parties
You or your agent should stay in contact with the intermediary, keeping them advised
regarding closing dates. They will be responsible for most of the paperwork associated
with the exchange, and may have specific lead-time or other requirements for each step
of the process.
Doing a Partial Exchange
If you plan to use only part of your proceeds for a 1031 exchange, consult with the
intermediary to make sure your sales contract is worded correctly. You might also want
to talk with an accountant to find out how the cash sale will impact your taxes.
Compare Intermediaries
Be sure to compare the services, costs, and references of several qualified intermediaries
before selecting one to handle your 1031 exchange. The work they do is essential to the
success of the exchange--make sure it's a trustworthy and experienced company or individual.
Ask as many questions as necessary to make you feel comfortable with the process. A tax
deferred exchange is not difficult to do, but there are specific steps you must follow to
make sure every aspect of the sale and purchase complies with US tax laws.
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