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Many owners of investment and business properties are not aware of the opportunity to save thousands of dollars in capital gains taxes by exchanging, rather than selling, these capital assets. A “Like Kind Exchange” under Section 1031 of the Internal Revenue Code (IRS) provides that the federal capital gains taxes are deferred when business or investment real estate or personal property is exchanged rather than sold.
Not sure what these things mean? Not to worry, we discuss each of these concepts in more detail below.
A qualified independent third party must be used to facilitate the exchange to satisfy the requirements imposed by the IRS for a valid 1031 exchange. Using a Qualified Intermediary ensures an exchange will receive favorable tax treatment. The Qualified Intermediary participates on the investor’s behalf by acquiring and conveying exchange properties and holding the sales proceeds.
To qualify as a tax-deferred exchange, the Relinquished Property and the Replacement Property must be of “like-kind” and the exchanged properties must be held either for investment or for use in the taxpayer’s trade or business.
Land is an example of investment property. A rental property is an example of property used in a trade or business. Generally, investment property may be exchanged for trade or business property. However, real estate must be exchanged for other real estate and personal property must be exchanged for other personal property. In the case of real estate, the type of property is not important.
Accordingly, land, office buildings, apartments, rental homes and condominiums are all real estate and qualify as “like-kind” property.
Section 1031 requires an Exchangor to identify its potential Replacement Property(ies) within 45 days after the closing of its Relinquished Property. Generally an Exchangor is limited to identifying three potential Replacement Properties.
In addition, an Exchangor must acquire its Replacement Property(ies) within 180 days from the closing of its Relinquished Property. The failure to meet either of these time requirements will prohibit the Exchangor’s ability to defer tax using a 1031 exchange.
Please contact us and we’d be happy to discuss 1031 exchanges with you!