|What Is A 1031 Exchange?|
What is a 1031 exchange and is it for me?
In the ever changing real estate market, there has been a very commonly used to tool to allow buyers and sellers to defer capital gains taxes. You may have heard of a 1031 exchange but may not know it well enough to take advantage of the tax deferment program.
What is a tax deferred exchange?
A tax deferred exchange is a method by which a property owner defers payment of federal capital gains tax by trading one property for another. A property owner sells one property and then buys another to avoid the capital gains taxes. The taxes continue to be deferred as long as the buyer continues to exchange into like-kind properties.
The term “like-kind” is often associated with 1031 exchanges and is also often a misperception. Like kind simply means that real property can be exchanged for real property. For example, a residential investment sale can be transferred into a commercial building purchase, it does not have to be another residential building.
What are the time frames of a 1031 exchange?
Once the Seller sells a property aka “the relinquished property”, the Seller has 180 days to close on “the replacement property”. The taxpayer must identify the replacement properties, up to three properties, within the first 45 days.
If more than three are identified, the total market value, based on comps of the properties cannot exceed more than 200% of the value at which the relinquished property was sold. If the value is more than 200% the buyer must buy at least 95% of the properties identified.
A one year holding period is required to for a property qualify for a deferment.
The obvious advantage is the deferment of the capital gains tax. It is also a method for real estate buyers to acquire more valuable and more leveraged properties which may increase cash flow.
What are the disadvantages of a tax deferred exchange?
The basis in the relinquished property carries over into the replacement property therefore the taxable gains will increase. The money is also still tied up in real estate and not liquid for use. Also, there are transaction costs to facilitate a 1031 exchange.
For more information regarding a 1031 exchange in your next transaction, please contact Barbara Lloyd, CCIM.
Barbara Lloyd, CCIM