REAL ESTATE INVESTMENT: Part I – Overview of 1031 Exchange
These days, the real estate market is steadily on the rise. So, if you are in the real estate investment game, you may find yourself with a good opportunity to flip a property, but you may not be ready to cash out. Good news. You can take advantage of the sale opportunity and parlay it without having to pay taxes on the gain . . . at least not now.
Under Section 1031 of the tax code, you can sell your property and reinvest some or all of the proceeds in another property without paying taxes on the reinvested money. Here is how.
Anyone and anything. Individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts and any other taxpaying entity are entitled to defer taxes through a 1031 exchange.
The simplest thing is a simultaneous swap of one property for another. That can be tricky to arrange sometimes, though. What if you are ready to sell but not yet ready to buy?
The rule is the sale of Property A and purchase of Property B must be mutually dependent parts of an integrated transaction. If you are not doing a simultaneous sale-purchase, then you will typically use an exchange facilitator and an exchange agreement. Here are the highlights.
- You have 45 days from the date you sell Property A to identify a potential Property B. The identification must be in writing, signed by you, and delivered to the seller or a qualified intermediary.
- The exchange must be completed no later than 180 days after the sale of Property A or within 180 of the due date to file your taxes (with extensions), whichever comes first.
The “like kind” requirement can be a treatise by itself if you are considering exchanges of personal property. Luckily, this article is limited to real property, which is much simpler. Most real estate will be like-kind to other real estate. Quality or grade do not matter. So, for example, a residential rental house is like kind even with a vacant lot. One notable exception is you cannot replace US real property with foreign real property.
Be careful about taking control of the sale proceeds from the sale of Property A. That can make the entire transaction taxable even if you do go on to use the money to purchase Property B. You want the proceeds to be designated for reinvestment in Property B and not be available for any other purpose. One way to avoid receipt of proceeds is to use a qualified intermediary to hold the proceeds until the exchange is complete.