What is 1031 Exchange?
1031 exchange (IRS Code of Section 1031) is an exchange that is used to defer the capital gain taxes. It provides an option to the investor to reinvest the proceeds from the sale of relinquished property to buy a new replacement property and defer the capital gain taxes. An investor has a timeline of 180 days to complete the exchange. As a result, the exchanger or the investor can use 100% of the proceeds to buy another property and defer the taxes.
Properties involved in 1031 exchange must be like-kind properties, and used for productive use in trade or business, income production i.e. rental or investment purposes.
1031 “Like-Kind” Exchange
1031 Like-kind Exchange is that under which swapping of like- kind properties take place between two parties thereby deferring the capital gain taxes on the exchange. Here the term like-kind is used to define the properties of the same nature. Basically, in a like-kind exchange, the tax payer doesn’t receive any profit from the sale of the relinquished property and can only exchange one property for another.
A 1031 exchange provides the investor with higher leverage, improved cash flow, increased potential for geographic relocation and potential property consolidation. In all type of real estate investment there is a degree of risk and there is no guarantee that the objectives can be met.
The strict timeline i.e. 45 days identification and 180 days to complete the exchange laid down by the IRS must be followed during the tax deferment exchange. The expert also known as qualified intermediary must be involved to complete the exchange. The proceeds received from the sale of the property must not be utilized by the investor as this is kept in a special type of account known as escrow account. This Escrow account is managed by the qualified intermediary and investor is not allowed to touch the cash. If an investor touches the cash then it can result in associated penalties plus immediate tax liabilities on him. Some of the advantages of like-kind exchange are:
- The biggest advantage of a “like-kind” exchange is that it provides leverage to the taxpayer. As the tax payer has the option to buy more valuable property by putting more money into the proceeds received from the relinquished property.
- It provides the option for investing in different properties, as the taxpayer gets the liberty to buy one or more replacement properties anywhere across all 50 states of the USA.
- What often troubles most of the investors, who own rental properties, is the high maintenance cost they pay regularly. The best way to get rid of these unnecessary expenses is to switch to NNN Lease Investment.
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