Generally, when you sell real estate, you have to pay tax on the gain from the sale of your property. This gain is caused either by the properly appreciating over time or by taking depreciation deductions for tax purposes.
No Capital Gains Tax!
A Section 1031 Exchange, named for the Internal Revenue Code Section, offers you the major exception to imposition of this capital gains tax. With a 1031 Exchange, when you sell business or investment real estate and replace it with other business or investment real estate, you can defer the payment of the tax that is normally due on the sale.
Only With Investment Property
If your objective is to use the proceeds from the sale of your property to buy more business or investment real estate, a 1031 Exchange can provide you with more funds for investment than can be achieved through the investment of after-tax proceeds from the sale of your current property.
A 1031 Exchange is not a tax loophole. It is a code section written by Congress specifically to allow anyone who meets its requirements to sell their property and defer paying tax on the gain. You should keep it simple. Let the complicated part be the job of the Qualified Intermediary. After all, they are getting paid to handle the exchange. Let them earn their fee.
Six things to know about 1031 Exchanges:
- In simple terms, the old property and the new property must be either bare land or rental property. If you meet this test, you can exchange any type of real estate for any other type of real estate.
- From the date of closing on the old property, you have 45 days to determine a list of property you want to buy.
- Also, from the date of closing, you have 180 days to close the purchase of one of the properties listed on your 45-day list.
- You cannot touch the money. By Law, the money is held by a “Qualified Intermediary” (sometimes also called an “Accommodator” or a “Facilitator”). You cannot leave the proceeds in escrow until the second property is acquired, nor can you have a friend, employee, broker or even your CPA or attorney hold the money for you.
- Whoever is the title holder of the old property has to remain the title holder of the new property.
- To avoid taxable gain, you must reinvest all your cash proceeds and buy a property of equal or greater value.