A 1031 exchange, or tax deferred exchange is the selling of a qualified home and purchasing a qualified home during a certain time frame. The process of a 1031 exchange is the same as any normal selling and buying of a home.
What makes a 1031 exchange different is that the transaction itself is thought of as an exchange rather than a sale. Due to the nature of the exchange and not the buying and selling, the taxpayer is then eligible for a deferred gain treatment.
In other words, a simple house sale would be considered taxable by the IRS. Meanwhile, a 1031 exchange would not be considered taxable.
The details surround a 1031 exchange are found in Section 1031 of the Internal Revenue Code. This is the section referring to Like-Kind Exchange Regulations defined by the US Department of the Treasury.
The Like-Kind Exchange Regulations detail the interpretation of the IRS form and the basic practices, rule and qualifications in completing a transaction worthy of being classified as a 1031 exchange. All Real Estate Investors who are thinking about purchasing a “like kind” property after the sale of his or her own property should consider meeting the necessary requirements to qualify for a 1031 exchange.
Otherwise, he or she will have to pay capital gain tax, which can amount to more than 20 to 30 percent depending on federal or state tax rates. There are two main rules that must be followed to qualify for a 1031 exchange.
The first is that the total amount that is earned from the sale of the investor’s property must be less than or equal to the total of buying the replacement, “like kind,” property. The second is that all of the money gained from the sale of the first property, must be used in the purchase of the second property.
If either of these rules are not followed, the investory will have to pay the 20 to 30 percent capital gain tax as well. However, if the rules are only partially violated there will only be a partial liability applied to the investor to pay taxes.
In other words, if the investor uses most of the money from his or her sale to purchase a new home, then he or she will only be taxed on the remaining amount of money. There are other specifications that determine whether or not an investor is eligible for a deduction.
For example, both of the properties have to be held by the owner for a specific purpose such as business or trade and as an investment. The proceeds of the sale must also pass through what is called a “qulified intermediary” (QI).
The sales proceeds cannot go to the investor or one of the investor’s agents. Otherwise, the proceeds from the sale will be considered taxable.
These qualifications must all be met within two specific timelines. The first timeline is known as the Identification period.
During the identification period, the investor who is selling the property must locate and state other replacement properties that he or she would be willing to purchase. It is very common for investors to find more than one property that they would like to purchase during this time period.
The identification period is exactly 45 days from the close of selling the previous property that the investor owned. This time period is not extended for anyone under any circumstances.
The rules stand even if the 45th day falls on a weekend or legal United State Holiday. The second timeline is the amount of time an investor has to obtain the new property.
This timeline is known as the exchange period. This period last until the end of 180 days after the first property is sold or the due date for the person’s tax return for that taxable year in which he or she sold the property occurred, which ever comes first.
Armed with this knowledge, a Real Estate investor can saved a lot of money. It can really pay off to be aware of you options.
Tommy Greene has worked since 1991 in property investments. He loves all things financial. He recommends (http://www.stanjohnsonco.com) for your property investment needs.
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