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1031 Tax Exchanges

A 1031 tax exchange is actually Internal Revenue Code 1031, which states that property owners can sell their property, then reinvest the money they earned from it in ownership of like-kind property while deferring the capital gains taxes. The 1031 tax exchange is often overlooked in real estate. This is unfortunate, as it can offer quite a few significant tax advantages to those who buy and invest in real estate.

Some of the benefits of a 1031 tax exchange include:

  • The ability to defer payment of capital gains taxes. When an exchange is done correctly and in accordance with the rules set forth, it can give real estate investors the chance to defer all their capital gains taxes. Basically, they receive an interest-free, no-term loan from the government when they reinvest the money.

  • Release from property management. The person leasing the new structure is responsible for renting out and then managing the property. This is advantageous to real estate buyers and investors, as it gives them respite from the duties of property management.

  • Upgrade or consolidate property. In addition to being able to upgrade, buyers using 1031 can also own multiple properties, instead of just one.

How do you file for 1031?
Basically, there are five different classes of property, or real estate, and include:

  1. Property that is used in taxpayers' business, or commercial

  2. Property that is held primarily to sell to customers

  3. Property that is used as a main residence.

  4. Property that is reserved for investment purposes

  5. Property that is used as a vacation home.

In order to take advantage of 1031, the property must be used in the taxpayers' business or for investment purposes and occasionally vacation property as well.

There are certain stipulations that go along with a 1031 tax exchange. The rules include:

  • The real property you sell and the real property you buy must both be held for productive use in a business or for investment purposes. This means you can't qualify for 1031 if you're purchasing a home. In addition, the property must be like-kind.

  • In order for the profit to be tax-free, it has to be passed through a qualified intermediary, not you or your agents or brokers.

  • If you keep any of the proceeds or use it on something other than reinvesting in like-kind property, it will be taxed; all the proceeds from the original sale have to be reinvested in the replacement property.

The replacement property must be subject to an equal level or greater level of debt than the relinquished property or the buyer will either have to pay taxes on the amount of the decrease or have to put in additional cash funds to offset the lower level of debt in the replacement property.

Is a 1031 Tax Exchange Right for Me?
In deciding whether or not 1031 is something you should take advantage of, consider your property. If you have real property that you will make money on once you sell it (this is usually property that has decreased in value for tax purposes or property that has appreciated in valuenaturally), then you will most likely qualify for 1031 and should consider it as a viable option.

A 1031 tax exchange can be a great advantage for those who are considering reinvesting in real estate.

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