1031 Tax Deferred Exchange
Understanding the 1031 tax deferred exchangelaw can be time-consuming, frustrating, and mind-boggling with all those lengthy explanations and technical jargons which only a real estate attorney can fully comprehend. For the rest of us, there are reasons why knowing this section of the Internal Revenue Code is truly beneficial, especially when you own a certain type of investment like a business or real estate property. For the smart American taxpayer who plans to sell his or her investment, the 1031 exchange can be your new best friend. Remember that capital gains can run as much as 30 percent with the state and federal taxes combined, and you need all the help you can get to avoid such huge losses. If you want to build your wealth, then, you may want to take an in-depth look on how 1031 tax deferred exchange can aid you in your financial strategy.
What exactly is a 1031 Exchange?
This is a section under the United States Internal Revenue Code that allows the exchange of a certain type of property to defer or avoid any capital gains taxes arising from sales. The 1031 tax deferred exchange law allows you to sell an investment or business property and replace or trade it with something alike, without you paying for income taxes. These income taxes are postponed until the time you decide to sell those properties and keep the cash from the sales for good. This will truly benefit those who want to avoid paying income taxes by exchanging properties for a lifetime. This means passing your properties to your heirs and the next generation, entirely tax-free.
Normally, there is no difference on what type of property you receive and how much the fair market value of the property is. Sometimes, this can create a problem between two people exchanging a piece of land. This is why provisions are placed in order to ensure a fair deal that will satisfy both parties. The IRS, however, demanded some changes in the 1031 tax deferred exchange law, which resulted to the Congress passing a legislation in 1984 that defined which properties of like-kind can be exchanged. This also included a time table for the completion of the exchange. Most often, a middleman ( bank ) is involved to allow the tax payer to transfer the property, wait for 45 days for the new property to be identified, and another 180 days to get it.
1031 Tax Laws
The 1031 tax deferred exchange law is legal and ethical, as long as the property is considered an investment like apartment, condo, farms, commercial or industrial properties. You are not limited in exchanging properties of similar structure. In fact, you can trade your land for a gas station and pay no taxes. The only property that will not qualify for a 1031 tax deferred exchange is the home where you live, or if you trade your business properties for a primary residential unit.
Are there exceptions? There are loopholes to this rule and here are the important things you need to keep in mind about the 1031 tax deferred exchange law:
1. The replacement property or asset must of the same amount or greater in value than the property being exchanged for.
2. If a dealer tries to assist in properties for resale, they cannot be exchanged. The dealer must hold the property long enough to be considered as an investment for exchange.
3. Don’t let any agent working for you to take control over the money received from the sale before an exchange happens, or the entire exchange will be forfeited.
4. Always document the intention for the exchange and have it in writing with a real estate office.
5. Don’t fail to identify and acquire your replacement property in time, or you will be disqualified from the entire exchange.
6. An actual exchange of properties must take place.
7. If you have not protected your sales proceeds from taxes, you can opt for a partial tax-free exchange where you will pay some income tax.
8. All exchanges must be related to business, trade, or investment.
9. Your income tax losses cannot be deducted if you plan to exchange your property, than sell it.
10. Increase your property’s appreciation value by exchanging problematic properties that need expensive repairs or maintenance to those that have little issues. This will save you time and money too.
Remember to always keep an eye for experts who can give you sound legal advices when it comes to 1031 tax deferred exchanges and never do this process all by yourself. Another reason to hire an expert is their in-depth knowledge in this field, specially when tax codes can vary from state to state. The last thing you want is to have your exchange forfeited and you paying up a huge sum for the property you no longer wanted to possess.
RESOURCES:
http://en.wikipedia.org/wiki/Internal_Revenue_Code_section_1031
http://homebuying.about.com/od/investmentproperties/a/102008_1031Exch.htm
http://www.wave.net/immigration/lawyer/tax_avoid.html
http://www.firstam.com/ekcms/uploadedFiles/firstam_com/Product_Information/Products/Delayed_Exchange/delayed-reduced.pdf
http://babyboomersandbeyondrealty.com/FAQ_1031.html
