A 1031 Exchange is a section of the IRS Code that grants investors the ability to make real estate investment gains without paying taxes on them when another “like-kind property” is purchased with the profit earned. In other words, investors can change the form and value of their investment without selling out or acknowledging it as capital gain. There is no limit on the number of times an investor can swap properties or “roll over” one property to reap the benefits of another. In an ideal situation, an investor will profit on the value of the property after each swap and only pay tax on it once he or she decides to sell for cash. When making smart real estate investments, it’s important to keep the different rules of 1031 exchanges in mind.
The Like-Kind Rule
To qualify for a 1031 exchange, an investor must swap the original property for one of the same value even if they differ in quality. Under 1031 exchanges, only those properties containing similar assets may be exchanged for capital gain. While the parameters for what is considered “like-kind” is broad, the property must be of the same nature in order for a 1031 exchange to be granted.
The Business Property Rule
A 1031 exchange is not permitted for personal use. Under these provisions, only business or investment property exchanges can qualify. For example, a residential home may not be swapped in exchange for another. In addition, personal property, such as franchise licenses, aircraft and equipment, do not fall under the boundaries of 1031 exchange. Under this rule, only real estate can be swapped under a 1031 exchange.
The Same Tax Payer Rule
A 1031 exchange requires that the name on the property being sold is the same name on the property being acquired. In the event that the taxpayer who takes ownership of the replacement is different from the name on the taxes from the relinquished property, the value will not be transferred in the exchange.
The No “Boot” Rule
Under the terms of a 1031 exchange, “boot” refers to the money or market value of the acquired property. Occasionally, the buyer can receive some money from the purchased property as long as he or she is willing to pay taxes on it. However, in order for the 1031 exchange deal to remain complete tax-free, no “boot” is allowed to be received by the buyer. In the event of a delayed exchange, an intermediary receives the cash until it used to purchase the replacement property.
The 45-Day Replacement Identification Window Rule
When a buyer’s property is sold, but the buyer is not ready to close on a replacement property, the intermediary will receive the cash earned from the sale. From that point, an investor has 45 days to identify the acquired property to the intermediary in writing. The IRS allows investors to name three potential replacement properties under the condition one of these three properties will be closed on.
The 180-Day Purchase Window Rule
In a delayed exchange, an investor must close on the acquired property within 180 days. Once the original property is sold, a business or investor has six months from that day to close on the new property.
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