What is a 1031 Exchange?
A 1031 Exchange is a process authorized by the Internal Revenue Service (IRS) where investment property or like-kind business is exchanged with no urgent tax liability to the owner of the property, known as exchanger. While 1031 exchanges are used mostly for real estate transactions, other depreciable and non-depreciable assets may qualify as well. As required by the IRS, during a 1031 exchange, a middle-of-the-road individual known as facilitator, accommodator or QI (qualified intermediary) must be present to facilitate the exchange.
Benefits of an Exchange
If you happen to have some property or business, then a 1031 exchange is an advantageous investment tool. You are probably aware that property sold or transferred for gain is not exempt from taxation and the taxes could pile up quickly. Being the property seller, the taxes you would have to pay in the end could add up to 40% or more whereas in a 1031 exchange, the exchanger is allowed to preserve for re-investment all equity of the property. This makes it possible for the exchanger to get hold of a replacement property that has a better location, offers superior cash flow, and requires less management.
Properties Qualified for an Exchange
Like-kind is the description of the property’s nature. Only like-kind property can be exchanged. Like-kind property widely refers to any real property located in the United States and in some of its terrains. Property, which is used for investment or business purposes, may also be considered like-kind property. In contrast, personal property is not like-kind to real property. Personal property therefore, can only be exchanged with another personal property deemed eligible.
Properties Ineligible for Exchange
The Internal Revenue Code 1031 was revised in 1986 to prohibit some property from being exchanged. These include personal residence (although the part of the residence that is used for investment or business purposes such as a home office may be exchanged), bonds, securities, stocks, notes, stocks in trade or other proof of financial obligation, goodwill of a company, and partnership gains. Also excluded from being exchanged are property possessed mainly for sale such as property retailed at once after being improved or after purchase, developed lots, and business inventory.
1031 Exchange Cornerstones
1. An exchange must take place, not a sale. Something must be given away, referred to as relinquished property, and something must be received in return, referred to as replacement property.
2. The properties being exchanged must be of similar classes. The relinquished property must be like-kind to the replacement property.
3. The napkin test must be satisfied in order for an exchange to be completely not liable for taxation. This means that the value of the replacement property should be greater than or equal to the value of the relinquished property (the property given up by the exchanger).
4. The party renouncing the relinquished must receive the replacement property.
Are There Timeline Requirements for the Exchange?
Yes. The exchanger has exactly 45 days gauged from the date when the relinquished property would close, to propose the potential replacement properties and 180 days to obtain the replacement property. Note that the exchange must be completed within 180 days, not 45 + 180 days.
Identification Rules
The exchanger must provide in writing a clear description of the potential replacement property prior to midnight of the 45th day, gauged from the day the relinquished property closed. A legal description of the replacement property would suffice. Apart from that, a submitted purchase contract is also considered enough identification. Moreover, property purchased and close within the 45 days can also qualify as identification.
Are There Exceptions?
Despite the exclusion of personal residences from 1031 exchanges, vacation homes and other second homes may be eligible if they meet certain conditions defined by the IRS on February 2008 in the IRC 1031.
Related posts:
- The Basics Of Virtual Stock Exchange In most virtual stock exchange, you will be competing with...
- Steps You Should Follow When Trying To Buy Property Pursuing an investment into any real estate can be a...
- Foreclosure Properties For Sale Guide If you're on the lookout for some great property to...
- Is It About Time For You To Buy Indianapolis Real Estate? Indianapolis real estate is surely a good avenue simply for...
- Fantastic Value And I Love It - Santa Barbara Real Estate Book Review They have already been contacted by a dozen before you....