If you own investment property that you want to sell to buy another property, you may want to know about the 1031 tax-deferred exchange. This refers to a practice in real estate industry that allows property owners of certain investment property to sell it and buy similar types of property while deferring capital gains tax.
A 1031 exchange is derived from Section 1031 of the U.S. Internal Revenue Code. This basically allows you to dodge paying capital gains taxes when selling an investment property, but you must, as required by the law, reinvest the proceeds from the sale within certain time limits in a like-kind property or properties of equal or greater value. Under this section of Internal Revenue Code, any or all proceeds collected from a particular sale of a property is still taxable. Because of that, proceeds from the sale should be transferred to an eligible intermediary instead of the seller of the property. The intermediary will be the one to transfer the funds to the seller of the chosen replacement property or properties.
An eligible intermediary can be a person or company that consents to facilitate the 1031 exchange by temporarily retaining the funds involved until they can be transferred to the seller of the replacement property. The intermediary must have no other formal relationship with both parties involved in the exchange of properties.
As a property investor, there are a several reasons why you may consider using a 1031 exchange. Among these may include but not limited to:
- Looking for a property that has much better return prospects or may want to diversify assets.
- As the owner of a particular investment real estate, you may be looking for a managed property instead of managing one yourself.
- Looking to consolidate several properties into one, whether for estate planning or you just want to divide a single property into several assets.
- Reset the depreciation clock of the property.
There are benefits of utilizing 1031 exchange instead of simply selling a property and then buying another one. The main advantage of this is tax deferral. Under section 1031, you are allowed to defer capital gains tax. This will allow you to free more capital you can use for investment in the replacement property.