Tax deferred exchanging is an investment
strategy that should be considered by anyone who owns investment or
business property.
Whenever you sell a business or investment
property and have a gain, you generally have to pay tax on that gain.
IRS Code Section 1031 offers you the opportunity to defer this tax by
exchanging the sold property for other property. This tax payment is
deferred until some date in the future. 1031 Exchanges are sometimes
referred to as "tax free exchanges" because the exchange
itself is not taxed!
According to the new IRS guidelines for 1031
you can defer tax on a sold property and take up to 180 days to purchase
a replacement property.
If you are considering a 1031 exchange you
should first determine whether or not you are a
good candidate.
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In order for a transaction to qualify for
tax-deferred treatment under Section 1031, certain rules must be
followed and certain requirements met.
Qualified property
All property, both personal and real, may
qualify for tax deferment under Section 1031. Some property is
specifically discounted:
- Stock in trade or other property primarily
held for sale, such as inventory
- Stocks, bonds, notes and other forms of
securities
The purpose usage
The property being sold must have been held for
either investment purposes or for productive use in a trade or business.
In addition, the taxpayer must intend for the new property to be used in
a like manner.
Like kind
To qualify under Section 1031 as a tax deferred
exchange, the relinquished property (that being sold) and the
replacement property (that being bought) must be "like kind"
property. Section 1031 defines "like kind" as similar in
nature or character, notwithstanding differences in grade or quality.
Generally, all real estate is like kind to other types of real estate,
regardless of whether it is improved or unimproved and regardless of the
type of improvement.
Exchange period
Once the relinquished property has been
transferred, the taxpayer has 45 days to identify one or more
replacement properties. Additionally, the taxpayer must close on the
replacement property or properties before the earlier of 180 days of the
transfer of the relinquished property or the due date of the taxpayer's
federal income return, including extensions, for the year in which the
relinquished property is transferred.
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The taxpayer may not want to sell property he
currently owns. It may meet all the requirements for location, ease of
management, and value for the dollars invested. However, one day it may
become evident that the property is not the tax shelter it once was.
Over time, the property will appreciate in value, but the basis in
improved property will decline. Through depreciation, the basis drops
annually. This drop in basis means that each year there are more dollars
not in use because they are tied up in the property. Eventually, the
taxpayer will see one of two reasons to sell:
- The taxpayer will want to get to those
dollars and re-invest them. This may not be expressed as a desire to
leverage, but it will be the result.
- The taxpayer will look for depreciation and
interest deductions, which arise from the acquisition of more
valuable property. The property which has been owned for some time
will realize small deductions compared to the new property which can
be acquired with leveraged funds at no additional out of pocket
cost.
Below you will find many other reasons why
taxpayers decide to do 1031 exchanges:
