A 1031 exchange is a great option to use if you have a business or investment property that you would like to sell but have concerns about taxable recapture. When you exchange properties there are some significant tax deferred benefits, whether you still owe on the property or if you own it outright.
The Internal Revenue Code section 1031 will allow you to defer taxes on capital gains if you exchange rather than sell your property, and it is available to both personal property owners and real estate owners. A 1031 property exchange may save you as much as 15 to 35% in state and federal taxes on each dollar of gain, depending upon your particular state’s tax rates. Of course there are certain guidelines and a few basic steps that need to be followed in order to take advantage of this type of tax deferred 1031 exchange. And, keep in mind that this tax deferred exchange is one of the few remaining tax benefits approved by the IRS.
The Internal Revenue Service has two main conditions that need to be met in order for property to qualify as exchange properties under the section 1031 exchange code; they define it as a “like-kind” exchange and that is the entire key to having the transaction validated.
The two types of property that are considered allowable as exchangeable properties according to the Internal Revenue Service are properties that are held for a productive use of trade or business and/or property that is used for investment purposes. If the owner determines that their property will qualify as a 1031 like kind exchange, then there are two additional steps that need to be taken so that they can take full advantage of the tax deferment. One of these steps is to acquire the replacement property, keeping in mind that it must have a value that is at least as much as the property that they wish to exchange. The second step is that all of the equity from the exchange property must be transferred to the replacement property. If these two steps are completed, then the tax free transaction should take place with no problems.
Of course, within this scope of the qualified tax deferments there are other important provisions and rules that do exist. Primarily, they deal with delayed exchanges, as the rules do have a set time frame during which the whole transaction with the exchange properties must take place. This time frame is 180 days, and investors must adhere to the approved methods that have been created by the Internal Revenue Service on dealing with how to identify any replacement properties that are to be acquired. The rules used in order to identify the properties are important in the completion of the 1031 exchange in order to qualify for the tax gain deferment. It is for this reason that it is a good idea to use an experienced tax advisor and a good qualified exchange intermediary.