One of the many questions that people ask a Qualified Intermediary of 1031 tax deferred exchanges is how long the relinquished property needs to be held to qualify for a 1031 exchange? The answer represents one of many ways to develop a fact pattern that supports a 1031 exchange. As you recall, a 1031 exchange allows the taxpayer to defer or postpone the payment of federal and state capital gains and depreciation recapture taxes, when real property held for the production of income for a business or investment is replaced with real property of equal or greater value than the relinquished property's net sales price. What is not eligible for tax deferral treatment is a primary residence, Section 121 transaction, or second home.Read More
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A 1031 exchange is found in the Internal Revenue Code Section 1.1031. The tax deferral allows federal taxpayers, both U.S. and foreign, to postpone paying federal and state capital gains and recaptured depreciation taxes when selling and replacing property held in a trade, business or for investment. A 1031 exchange is an indefinite, interest free loan that can amount to more than forty percent of the sales price. The tax is ultimately due when the replacement property is sold unless another 1031 exchange is initiated.
1031 real estate exchange rules define how to go about deferring federal and state capital gains and recaptured depreciation taxes when selling and replacing a real property investment. A 1031 exchange, or Internal Revenue Code (IRC) Section 1.1031, allows any entity, both U.S. residents and foreign non-residents, to defer or postpone the payment given certain 1031 real estate exchange rules are strictly followed. The first step is to be aware that the taxes can be deferred indefinitely or until the replacement property is sold. Taxes, both federal and state, along with a twenty-five percent recaptured depreciation tax, can amount to upwards of 40 percent of the property’s sales price. If you could be given up to 40 percent of the real estate sales price interest free to use towards acquiring replacement property, wouldn’t you ask what the 1031 real estate exchange rules and requirements are?
Given the current tight credit market, taxpayers who want to initiate a 1031 exchange may consider financing or carrying a note for a Buyer to acquire the relinquished property. A 1031 exchange is a strategy to defer the federal and state capital gains and recaptured depreciation tax when selling and replacing property held for productive use in a trade, business or for investment. The tax deferral represents an indefinite, interest free loan that can defer upwards of 40 percent of the sales price. 1031 eligible property includes real property such as timberland, self-storage units, commercial property, single family residential, oil and gas royalty interests as well as personal property including aircraft, precious metals, vintage cars, artwork and collectibles.
Taxpayers frequently enter into a Section 1031 Exchange instead of a traditional sale to avoid the often substantial capitals gains and recaptured depreciation tax obligation due as the result of gains realized upon the sale of real and personal property held for productive use in a trade, business or for investment. If the transaction meets all the requirements of a Section 1031 Exchange, any tax due on the gains realized as a result of the exchange are deferred. Understanding how a Section 1031 Exchange differs from a traditional sale, as well as a full understanding of the rules required for a transaction to qualify for a 1031 Exchange, is essential to taking advantage of the capital gains deferral offered by the exchange.
Buying and selling property with a 1031 exchange can be a very lucrative investment when done properly. Simply understanding the market, however, is not enough to ensure turning a profit. An investor must also understand the various tax consequences involved in real estate transactions. In the normal course of business, capital gains taxes are incurred whenever a taxpayer sells property and realizes a gain on the sale. One method that can be used to defer the payment of capital gains taxes is to enter into a Section 1031 Exchange instead of a traditional sale. In essence, a 1031 exchange involves the taxpayer relinquishing one property and acquiring a replacement property of “like-kind” within 180 days of the relinquishment. One of the rules of a 1031 exchange requires the same taxpayer to complete both ends of the exchange. While this may sound simple enough, there are some circumstances where the identity of the “taxpayer” for purposes of the exchange can become complicated.
Internal Revenue Code Section 1031 has many 1031 exchange rules that start with the code itself: “No gain or loss is recognized when property held for productive use in a trade, business or investment is exchanged for property held for productive use in a trade, business or investment.” A 1031 rule is to hold the property for the proper intent - or not for predominant personal use. Without proper intent, the 1031 exchange is not eligible for consideration.
As a general rule, anytime you sell property, the gain you receive as a result of the sale is subject to capital gains taxes. For example, if you purchased a property five years ago for $100,000 and now wish to sell it for $150,000, you would be subject to paying capital gains taxes on the gain of $50,000. One strategy that allows you to defer capital gains is to enter into a 1031 Exchange. Section 1031 of the Internal Revenue Code can provide an effective mechanism for deferring the payment of payment of capital gains taxes if the 1031 exchange guidelines are followed.
In a traditional sale of property, the seller is required to pay capital gains taxes on any gain realized in the sale. One way to avoid paying capital gains taxes is to defer payment by entering into a Section 1031 Exchange. As the name implies, a 1031 Exchange contemplates an “exchange” of like-kind property instead of a traditional sale. If the transaction qualifies, any realized gain is deferred until the replacement property is sold at a later date. The Internal Revenue Service Code sets forth the requirements that must be met in order for a transaction to benefit from 1031 Exchange treatment. In addition to the requirements found in the IRS Code, Qualified Intermediaries must follow additional rules legislated by the State of California for exchanges where the old or relinquished property or the property parked with the Exchange Accommodator Titleholder is located in California.
Section 1031 is a useful section of the tax code that allows a taxpayer to defer taxable gains on a property by using it as an exchange rather than a simple sale. In order to successfully fulfill a 1031 transaction, you need to follow the specific 1031 exchange requirements. The 1031 exchange rules are very precise and need to be followed exactly in order to get the tax deferred exchange.