Sitting on a load of equity in your investment property can have you scratching your head. What is the best way to get out the most profit? A Section 1031 Tax Free Exchange can be a great way to reinvest your profits while dodging a daunting tax bill from Uncle Sam. Decoding the 1031 Exchange can be the best thing you do to extract the most money from your profitable investment,
A tax-deferred exchange allows investors to sell a piece of investment property, and quickly reinvest the proceeds for “like-kind” property. The new property is seen as a continuation of the original investment, so taxes are not due at the time of the sale. When you sell the next property taxes would then be due unless you do another 1031 Exchange, of course!
The requirements for your present investment property are much easier then years past. Previously, if you had apartments to sell you had to buy apartments. Now the definition of “like-kind” has broadened considerably to apply many similar investments. You can sell land and buy a duplex, or sell an apartment building and buy an industrial building. So most long-term real estate investments qualify.
One big hurdle you must be sure to clear is the property must have been originally bought for an investment not speculation. You can’t buy it and quickly resell it and hope to get a tax break. Generally holding a property for at least 18-24 months is considered the minimum for considering a Section 1031 Exchange. So if you have held the investment property for a shorter time you probably aren’t eligible. The law works this way because the government wants to reward long-term investment, not speculation.
So for the first part of qualifying for a Section 1031 Tax Free Exchange is hold the property long enough. How about the property you want to “exchange” for? That is more complicated. Within 45 days of selling your original property you must file a document identifying your potential exchange property. Realize you don’t have to buy all of them although you can you just need to buy enough of the identified properties to make the “exchange.”
You can’t file this yourself, though. When you get ready to do a tax-deferred exchange, you will need the services of a qualified CPA or Attorney. You will need to search out a good intermediary. There are dozens of companies, many national in scope, that facilitate 1031 Exchanges. Many CPAs and Attorneys can also act as the “disinterested party.”
The maximum number of replacement properties that you may identify is three properties. You also may identify any number of properties provided that the total value of these properties is not more than 200% of the value of the original property you are selling. You have 180 days after the date you transferred the property you are relinquishing or after the due date of your IRS tax return (including extensions) for the year in which you made the transfer. For multiple property transfers, the 45-day identification period and the 180-day exchange period are determined by the earliest date a property is transferred.
Once you have identified the exchange properties, you have up to 180 days to complete an exchange, but the period may be shorter. You have 180 days after the date you transferred the property you are relinquishing or after the due date of your IRS tax return (including extensions) for the year in which you made the transfer. For multiple property transfers, the 45-day identification period and the 180-day exchange period are determined by the earliest date a property is transferred.
One major item to be aware of is “Boot”. Boot is defined as any money or any type of property of unlike kind (example, a car received as part of down payment). You will be taxed on this boot regardless of whether or not you carry out the exchange correctly. You will want your exchange company, or attorney to examine your transaction closely to make sure you don’t receive anything that could count as boot. Also, special rules apply for exchanging property with assumed mortgages.
It seems complicated and it very well can be. But considering you can save tens of thousands of dollars, or more, in taxes on your profits make it worth it. Decoding the 1031 Tax Free Exchange is important to any investor. Learn what you need and find a good Exchange Company, lawyer or accountant to see how it applies to you. You’ll never regret it.