Capital Gains Taxes: Is a 1031 Tax Exchange Right for the Sale of Your Investment Real Property?

You’re selling your investment property and heard somewhere, from someone, that the sale could create a responsibility on your part to pay capital gain taxes.  Naturally, you’re concerned, especially when you need every dollar from the sale to put into the new investment real property you hope to buy. One option that may be available to you is to participate in a Tax Deferred Exchange under Section 1031 of the Internal Revenue Code of 1986. 

A § 1031 Exchange allows the owner of investment real property to defer payment of taxes while they trade one or more of their properties for one or more replacement properties of “like-kind.” In other words, the § 1031 Exchange allows you to exchange your investment real property (“Relinquished Property”) for other investment real property (“Replacement Property”) and carry forward the taxes on the sale of the property (the “Deferred Exchange”) as long as the requirements of the Code are strictly followed. The idea behind the § 1031 Exchange is that as long as the sale proceeds are reinvested in a property of “like-kind”  the investment is basically the same, only the form of the investment has changed, and taxes should not be accessed until a later time.

5 Points to consider when determining if a 1031 Tax Exchange Is right for your transaction:

  1. While the tax-deferred exchange allows you to reinvest sales proceeds that otherwise would be required to be paid in taxes at the sale, the exchange is not as straightforward as simply selling Relinquished Property and using the money to purchase Replacement Property.  I can’t stress enough how important it is to consult qualified tax professionals, real estate agents and attorneys who are familiar with the requirements of this type of transaction. These professionals understand the tax ramifications associated with this type of transaction.

  2. The real estate involved in the transaction must be investment real property.

  3. Replacement Property must be identified within 45 days of the day the Relinquished Property is sold.

  4. Within 180 days of the conveyance date of the Relinquished Property or the due date of the tax return for the year in which the transfer takes place, whichever is earlier, the closing related to the replacement property must occur.

  5. An experienced exchange professional known as a Qualified Intermediary (QI) must be used to hold and control the sales proceeds from the sale of the Relinquished Property until the exchange is completed. It is important to select a knowledgeable QI, and other real estate professionals to assist in the exchange transaction, as the Landowner (taxpayer), QI and others assisting in processing the exchange must take great care to comply with the regulations of the tax code or face the consequence of having the Deferred Exchange disallowed under audit. 

The above are just a few of the many items to know in regard to § 1031 Tax Exchange. Before beginning the process of the exchange, contact your tax professional, and/or attorney to determine if you may be able to enjoy significant deferred tax savings by completing a Tax Deferred Exchange. The Bottom Line: The key to a successful exchange is selecting qualified professionals to assist you in processing your transaction. 

Published by Wendy Hughes on November 4, 2016