Over the years of building careers and accumulating assets, many acquire investment and commercial properties. When the time comes to reconfigure a real estate investment portfolio or convert business property, the tax-deferred 1031 exchange enables postponement of capital gains tax.
Federal tax law allows taxpayers to defer capital gains tax on the exchange of property used in trade or business or held for investment. A 1031 exchange postpones but does not eliminate taxes and it involves an exchange of like-kind real estate. It is treated under the tax code as a continuation of the ownership of the property instead of a taxable sale.
Replacement property must be identified within 45 days of transferring the relinquished property and it must be acquired (closed) within 180 days of transferring the exchange property or the tax filing deadline, whichever comes first. There is no limit on the number of properties that may be relinquished. However, there are a few limitations on the replacement properties that a tax advisor is best to discuss.
Like-kind does not refer to the type of property; instead, it addresses the use of the property. For example: A condominium can be exchanged for a duplex; a rental house for a multiunit rental; bare land for an apartment building. A personal residence cannot be used for an exchange, nor can domestic properties for foreign properties.
There are many benefits to using a tax deferred exchange:
- Increase equity by deferring capital gains tax
- Acquire property with more appreciation potential
- Relocate or increase investment holdings in another location
- Obtain space for business expansion
- Dispose of underperforming property
- Increase estate value by acquiring more valuable properties
Working with a qualified tax advisor and legal advisors who know and understand the rules and regulations for a 1031 exchange is extremely important. And while a qualified intermediary or accommodator is not technically required by law, it is highly recommended to contact such an expert for proper guidance.