The 1031 Exchange is a smart tax saving option that is becoming popular among real estate investors by allowing them to defer their capital gains tax. The 1031 Tax Exchange was created in 1990 by the Internal Revenue Code Section 1.1031, Which gives investors an option to defer their capital gain taxes on the sale of real property by re-investing the gains into a “like kind” property. However, you do need to have a thorough knowledge of the terms and conditions that apply and exactly how the 1031 Exchange works.
The basic thing that you should know about a 1031 Exchange is that only business and investment property qualify for the tax deferral under Section 1031. Also, the property involved in the transaction must be of “like kind”. The phrase “like kind’ has often been misunderstood to mean that if someone is selling a 4200 sq. ft. office building, he must invest the money from this sale to buy another 4200 sq. ft. office building. However, this is not always the case. The term “like kind” actually has a very broad meaning. It can encompass any real estate held for productive uses in business or for investment. For personal property to qualify, it must be part of the daily operations of a trade or business and depreciable. For example; automobiles, office equipment, furniture, computers, franchise licenses, and the like can all be qualified. A 1031 Tax Exchange does not apply to cash, stocks, securities or other properties held primarily for sale.
The real property to which the rules of a 1031 Exchange apply includes land, single family dwellings, multi-family dwellings, hotels, office and factory buildings, shopping centers, farmland, etc. Note that all the proceeds gained from the sale of a property should be transferred through a qualified intermediary and not by the beneficiary so no one can use the money for a financial gain. To defer the capital gains tax, the profits must be re-invested in a “like kind” property, which must be of equal or greater value than the exchanged property. Also, the time interlude allowed for the re-investment should be followed. After selling the exchangeable property, a alternate property must be identified within 45 days and the exchange must be finished within 180 days.
Deferring capital gains tax is not the only advantage that one gains from 1031 Exchange. The are also some hidden benefits, like the fact that re-investing in another property can considerably add to your assets. Additionally, as the property appreciates in value, you can simply upgrade to a property of higher value with the added cash flow. The 1031 Exchange also provides the ability to exchange rental properties that may have appreciated in value in some hot markets and re-invest into less well known areas that are projected to appreciate in value and become the next hot markets in the near future.