What is a 1031 Exchange?
Internal Revenue Code Section 1031, or as it is more commonly known, 1031 Exchange, allows an investor to defer all immediate taxable liability on the sale of investment real estate indefinitely, as long as they purchase another investment property within a defined period of time and by meeting certain federally regulated guidelines.
Characteristics of a 1031 Exchange
A tax-deferred exchange is a transaction involving the sale and purchase of investment property or property held for productive use in a trade or business which meets requirements of Section 1031 of the Internal Revenue Code and qualifies for non-recognition of gain or loss. Technically, the exchange is tax-deferred, not tax-free, since the gain deferred in the transaction will be recognized on the ultimate sale of the replacement property received in the Exchange. During a tax-deferred exchange, the investor may not have constructive receipt of their exchange funds. Therefore, a Qualified Intermediary (QI) as an independent third party is needed to facilitate a 1031 Exchange transaction and hold the funds on behalf of the investor.
What are the advantages of a 1031 Exchange?
By deferring the tax, investors are in effect, receiving an interest-free loan from the federal government, in the amount they would have paid in taxes. Gains from depreciation recapture are postponed. Investors can proactively cut their tax burden by reallocating their investment portfolio, acquiring and disposing of properties without paying taxes on any gains. Assuming the value of their investment properties increase, the investor can repeatedly trade up, enriching their portfolio, all while repeatedly deferring taxes. Upon the death of the property owner deferred tax on any capital gains is forgiven and heirs receive a stepped-up basis equivalent to fair market value.
Value Requirement
Another critical component for completing a valid 1031 Exchange is the “value requirement.” Like-kind properties in an Exchange must be of similar value as well. The difference in value between a property and the one being exchanged is called boot.
If a replacement property is of lesser value than the property sold, the difference (cash boot) is taxable. If personal property or non-like-kind property is used to complete the transaction, it is also boot, but it does not disqualify for a 1031 exchange.
What properties qualify for a 1031 Exchange?
Any property that is “held for investment” or “for use in a trade or business qualify for 1031 exchanges. Examples include:
What strategies qualify for Like Kind exchanges?
FINRA BROKERCHECK —PJ Lynch
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No offer to buy or sell securities is being made. Such offers may only be made to qualified accredited investors via private placement memorandum. Risks detailed in a private placement memorandum should be carefully reviewed, understood and considered before making such an investment. Prospective strategies and products used in any tax advantaged investment planning should be reviewed independently with their tax and legal advisors. Changes to the tax code and other regulatory revisions could have a negative impact upon strategies developed and recommendations made. Past performance and/or forward looking statements are never an assurance of future results.
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