Have you heard of the 1031 exchange? Most likely not.
This is because the information you are about to learn about the 1031 exchange will be an excellent tool for increasing your cash flow. All you have to do is sell a qualified property, execute a 1031 exchange properly, and delay paying taxes on your gains.
The IRC Section 1031 allows investors to postpone paying their gains if they reinvest the said gains in a similar “like-kind” property. These are the rules and keys you should have in mind concerning the 1031 exchange:
1. Qualification For The 1031 Exchange Is Only For Particular Assets And Entities
This is how a Roth IRA Works for deferred taxes: When you make a transaction from your retirement plan, your gains are not taxed. This happens because you exchange one income-producing asset for a similar one, making it impossible for the taxpayer to receive anything that can pay the taxes.
The only time you pay taxes is if you withdraw cash from the IRA. The same applies to 401(k) plans. Well, this is precisely how the 1031 exchange works for real estate investments. So is a 1031 exchange a good idea? If you keep reinvesting your money in the same real estate assets, your gains will not be taxed.
Primary taxpaying entities that qualify for the 1031 exchange include individuals, partnerships, trusts, C corporations, LLCs, and S corporations. Properties excluded from Section 1031 treatment include stocks, bonds, notes, certificates of trust, inventory or stock in trade, and partnership interests.
2. Handling The Execution Of The 1031 Exchange Happens Via A Qualified Intermediary
On every sale made, the IRS demands a constructive receipt of the funds. This is what provides the number of taxable gains. Hence the need for a qualified intermediary. The intermediary is the individual or entity that holds all the profits from the sale.
They then wait for the new exchange property and invest all the money from the sale into buying the new property. According to the IRS, the intermediary is qualified because their individual mission is to facilitate the exchange.
Therefore, you or your agent cannot act as the intermediary. Remember, the only way you can qualify for the 1031 exchange is if all your sale proceeds are reinvested into the new purchase. Holding off any amount from the sale will call for 1031 exchange rules – you will incur a taxable income.
3. Only Like-Kind Properties Qualify
As mentioned above, the 1031 exchange is only viable for like-kind properties. These are properties that share the same class, nature, and character. Thus, if you are unsure if the property will be up to your standards, you will want to look into insurance to cover your home.
Also, personal and real property can qualify as like-kind. But, real property is not like-kind to personal property. The like-kind rules for personal property exchanges are more restrictive. As exceptions, properties in the U.S. are not like-kind to those outside the nation, and real estate purchased for resale are not Section 1031 treatment eligible.
4. Timing Is Essential
You know how detail-oriented you can get when teaching kids about money, you should be much more concerned about the 1031 exchange rules and time limits.
There are two 1031 exchange time limits needed to complete the exchange:
- Identification period: Provides only 45 days from the day you sell your property to identify the potential purchase. ensure you write, sign, and deliver the identification to the intermediary or replacement property seller. Provide that the replacement property is described entirely using the IRS guidelines.
- Exchange Period: Offers 180 days from the day the exchange property is sold to the day the replacement property is received. This means the replacement property must be acquired within 180 days of the original property sale closure. This may even have you wondering, “what do mortgage closing costs cover?”.
5. Hold The Properties As Investment Or For Productive Business Purposes
The property you sell and the one you buy must be held for two reasons:
- For the productive and active use in a business or trade
- As an investment that should either increase in value or generate income, such as vacant land intended for future sale or a rental property respectfully.
The 1031 exchange doesn’t qualify for personal-use properties or investors buying, rehabbing, and reselling distressed properties. Nevertheless, a vacation property can be eligible following these rules in a two-year minimum period before and after the exchange if you’ve:
- Rented the property two weeks minimum to a non-relative
- Used the property personally only 10 percent of the rented time
- Rented to a relative, as their primary residence, at a fair market price
- Maintained the property for an unlimited and documented amount of time
- Reported the income from the property on your tax return Schedule E
6. Gains Are Tax-Deferred, Not Tax-Free
A 1031 exchange tax FAQ worth knowing: your tax is deferred, not eliminated. This means when you eventually sell the new property you will have to file taxes for your recent gains. The silver lining is that there is no time limit to holding the property, and you can keep practicing recurring 1031 exchanges on each new property.
is not as vital as distinguishing the deferred exchange from a taxpayer selling a property and buying a new one. Take a moment from trying to determine “is a 1031 exchange a good idea?” and research the 1031 exchange. There is massive misleading information about like-kind properties to discern. Finding the best 1031 exchange companies can help relive the weight of stress on your shoulders.
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