Real Estate Law
When a business or individual sells a property for profit, that profit is generally capital gains tax. However, if the business sells the property and reinvests the proceeds into a similar property, the business can defer paying taxes on the profit. A 1031 exchange is a tax rule that allows for like-kind exchange of investment property that does not trigger taxation.
Like-kind exchanges involve federal tax laws but buying and selling business property can involve state and local property and tax laws. When looking for answers about exchanging investment property, contact your local real estate lawyer for legal advice.
A “1031 exchange” is named after section 1031 of the U.S. Internal Revenue Code. Under IRC 1031, investors can defer capital gains taxes on the exchange of like-kind properties. A 1031 exchange is a tax-deferred benefit but not tax-free.
Like-kind exchange tax deferral is available for owners of investment properties, including individuals, corporations, and partnerships. The properties must be held in use in a trade or business or investment.
Properties eligible for a 1031 exchange can include any property owned for investment or business use, including apartments, retail space, office buildings, or vacant land. However, property primarily used for personal benefit, like a vacation home, does not qualify.
A like-kind exchange has a time limit. There are some time restrictions to follow when making a 1031 exchange. If either time limit is exceeded, the proceeds on the sale may be taxable.
The simplest exchange involves a simultaneous swap, when one property is sold and the other property is purchased. However, a like-kind exchange does not need to be simultaneous. If the exchange is not simultaneous, the sale proceeds have to be held by a 3rd-party until the replacement property is purchased.
- 45-Day Identification: The property has to be identified within 45 days from the date of relinquishing the property. Identification has to be in writing, signed, and delivered. The identified property has to be clearly described, including the address, legal description, and name. An investor can identify more than one possible replacement property within the 45 days but there are limits to the number and value of properties that can be identified.
- 180-Day Completion: The exchange must be completed no later than 180 days after the sale of the exchanged property. The replacement property must also be substantially the same as a property identified in the first 45 days.
The inclusion of properties that qualify as “like-kind” can be very broad. Like-kind property is of the same nature, character, or class. A rental home could be considered like-kind to purchasing vacant land for a building project. In general, real estate is like-kind to other real estate investments. However, there are a few restrictions that are not considered like-kind, including:
- Stocks and bonds
- Securities and debt
- Partnership interests
An investor owns 3 rental apartments on the beach. The investor sells the apartments, with $1 million in gains. If the investor does not make a like-kind exchange, the investor will be taxed on the $1 million. If the investor makes a like-kind exchange, the investor would defer taxation on the gains.
If the investor sold the property and intended to purchase another property but could not find the right property for 60 days, then the investor would likely have to pay tax on the gains because no like-kind property was identified within 45 days of the sale of the exchanged property.
You can purchase the replacement property before the exchanged property is sold. This is known as a “reverse exchange.” A reverse exchange involves acquiring the replacement property through an exchange accommodation titleholder, who acts as an intermediary. The titleholder can hold the property for no more than 180 days, giving the investor time to relinquish the exchanged property.
This article is intended to be helpful and informative. But even common legal matters can become complex and stressful. A qualified 1031 exchange lawyer can address your particular legal needs, explain the law, and represent you in court. Take the first step now and contact a local 1031 exchange attorney to discuss your specific legal situation.
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