A 1031 exchange, also known as a Starker or like-kind exchange, is a powerful tax deferment procedure that permits investment property owners to sell real estate they currently own and buy like-kind property while deferring capital gains tax.
A 1031 exchange is named for the Internal Revenue Code tax section that states:
In this post we’ll cover the key points of a 1031 exchange including the rules and definitions you should know before proceeding.
It’s critical to understand the terms used in a 1031 exchange. For instance, many people mistakenly believe “like-kind” means you must buy a property exactly like the one you sold. But what matters under the code is that the asset be held for investment or for use in a business or trade, and that it not be a personal residence. For example, timberland is considered real property for 1031 exchange purposes, which means as long as all other conditions hold true, you can exchange it for a rental condo.
One important caveat: If the property you’re relinquishing is in the U.S. or its territories, the replacement property must also be located there as well.
There are also timing considerations. For example, you must identify the new property or asset you’re purchasing within 45 days of the sale of your existing property (more on timing in the conclusion).
Tax-deferred exchanges allow you as an investor to defer capital gains taxes and facilitate meaningful portfolio growth and increased return on investment. Case in point:
There are several reasons for choosing a 1031 exchange investment. You may want:
One important caveat to 1031 exchanges: They can require comparatively high minimum investments and holding times. For that reason, a 1031 can be more ideal for individuals with higher net worth.
There are two important ways using a DST makes owning investment real estate less stressful.
Qualified intermediaries, also known as accommodators, facilitate 1031 tax-deferred exchanges.
Remember, under section 1031 of the IRS tax code, any proceeds from the sale of an investment property remain taxable. When you decide to do a 1031 exchange, the proceeds from the sale of your existing property cannot be transferred to you personally; they must transfer to a qualified intermediary, a “disinterested” third party who enters into a written agreement with you and:
The logic behind this procedure is that since you, as the taxpayer, do not take actual receipt of the sales receipts, no capital gains taxes are triggered. It’s also the reason you cannot use a CPA or attorney as an intermediary, as they are “interested” parties working on your behalf. (You cannot use your own CPA or attorney if they have represented you in the past two years.)
A qualified intermediary can reduce the complexity of an exchange and provide you with the proper guidance and information you need for a successful transaction.
There are other factors you need to consider before investing in a 1031 exchange. As mentioned, timing and various other rules apply. You must:
There are expenses and fees involved as well, some of which can be paid with exchange funds while others may not. And estate-planning considerations must be addressed.
The tax deferment you realize with a 1031 exchange is a wonderful investment opportunity for you and your heirs. Though it can be a complex process, those complexities are what also give it its great flexibility. For this reason, it’s not a procedure for investors acting on their own. Competent professional assistance at every step ensures a smooth and legal exchange.
Turner Investment has extensive experience in managing the entire 1031 exchange process for our clients. We work with you to provide the right replacement assets when you need—and want—them most. To learn more about 1031 exchanges and whether using one is the right choice for you, contact us today. We’d love to talk with you about your investment options.
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