1031 Exchange: How To Defer Your Capital Gains Taxes

What is a 1031 Exchange?

For a detailed explanation you can check out this very thorough page at Wikipedia.

However, in essence Section 1031 of the Internal Revenue Code allows you to defer the payment of capital gains taxes that would otherwise be due on the sale of a property if you exchange it for another appropriate property.

If you are a real estate investor it is obviously in your interest to do your home work on 1031 exchange rules. It could save you many thousands of dollars in taxes, and could help you avoid many of the pitfalls and problems associated with 1031 tax exchanges. By doing a little research you can maximize and optimize your tax deferrals.

1031 Exchange Rules

One of the most important things to know about 1031 exchange rules are the deadlines. You must purchase a replacement property within one hundred and eighty days after the sale has been registered or before the next filing deadline. But there is also a forty five day identification period in which time you must use one of three methods to identify properties that you are considering for exchange.

To maximize your tax deferrals, all of the cash from the sale of the property must be reinvested into the new property. The 1031 exchange rules state that you cannot use proceeds from the sale to pay for expenses that are not part of the exchange. To get the maximum tax benefit from these expenses you should handle them on a separate part of the settlement and footnote them and write a separate check to the buyer.

If you live in a different state to where the property is sold, many states mandate that the closing agent or real estate agent must withhold a percentage of the sale price to make sure that the state receives any tax revenue due, because tracking down these non residents later can be very difficult.

The real property tax act of 1980 as it pertains to foreigners requires that at least ten percent of the sales price must be withheld for this purpose. This withholding requirement can be waived depending on the state, so it's important to check your state's individual rules.

Finally and most importantly, you must use a qualified intermediary who completes all the necessary paperwork and filing and must adhere to the 1031 exchange rules. There are many places on the internet where you can find such intermediaries.  You can start by making sure they are members of The Federation of Exchange Accommodators (FEA) - www.1031.org.

Further Resources

www.blog1031.com
www.1031podcast.com
www.ipx1031.com
www.starker.com
www.investorschoiceindy.com

 

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