Interest in the 1031 Reinvestment has mushroomed 3 years ago. The number of 1031 exchanges has, according to tax experts, grown by over 25% in that time. Today, 1031 exchanges are a major driving force behind activity in the commercial and investment real estate markets. So what is a 1031, what good can it do the real estate investor, and what is required to make it work for you?
Section 1031 of the US Internal Revenue Code provides, within certain limits, a way of deferring capital gains taxes on profits earned from the sale of real or personal property. Please note that this document is not intended as financial guidance in conducting your own 1031 transfers. The tax laws regarding 1031 transfers are complex. Please seek the guidance of a competent tax professional and a real estate agent who is versed in the issue and can provide accurate professional advice. This document is intended only to give you a glimpse of the possibilities to enhance your real estate investment growth.
The first important fact to keep in mind is that 1031 exchanges do not render profits from capital gains tax free! They merely provide a deferral of such taxes. Therefore, it is often wise to combine your 1031 investment strategy with other estate planning moves that a good investment advisor may suggest and that may lessen the tax burden from those deferred capital gains taxes.
The Equal or Greater Value rule states that the thing you buy as a replacement to complete the exchange must be of equal or greater value than the property you sold. Otherwise, whatever portions of the proceeds of the sale are not reinvested will be subject to capital gains tax in that tax year. They don't get covered by the deferment.
Next, there is the Like Kind rule. Personal property such as collectibles and art and the like are pretty strictly controlled. Selling a priceless Monet painting and investing the proceeds in a 1929 Duesenberg
Convertible will definitely not qualify, no matter how much of a work of art that automobile may be. Collectible cars for cars, art for art and so forth. Fortunately, the Like Kind rule isn't nearly so tightly
interpreted when it comes to real estate. Both properties must be within the United States, but such diverse property types as apartment buildings, single-family residences, business property and undeveloped land all qualify. You can even trade 1 property for multiple properties or vice-versa. If you hold a long term lease (for more than 30 years) and have options to renew that may be exchanged for a fee interest. Be sure to check with your agent and tax advisor before ruling in or out potential 1031 real estate exchanges.
Lastly, there is the Time Issue. You must identify (in writing properly executed) the replacement property within 45 days of sale and close on it within 180 days of sale of your prior holding. Day one starts when escrow closes on the sale of your prior holding. The investor must NOT take possession of the proceeds of the sale to be exchanged. Those proceeds must be held in a trust account by an independent qualified intermediary (QI) third party. So clearly, before sale of your property, your agent needs to know of your intention to use it in a 1031 exchange.
There are very specific and rather tedious rules about identification timing and methods. Rather than try to list them all here and potentially confuse or mislead someone, let it suffice to advise that as you
work with us, or with any qualified 1031 real estate exchange agent, be sure to disclose you wish to access the 1031 Tax Deferral Rule as soon as you possibly can. In this way your agent can do a much better job of ensuring that your investment growth and tax deferral interests are best served during the exchange.