Understanding The Basics: 1031 Tax Deferred Exchange for Real Estate

If you’re a property developer, investor, or real estate company, you should be familiar with IRC Section 1031 for your real estate reporting. This code provides an effective tax strategy for exchanging one real estate investment or business property for another of like-kind and equal or greater value.

Continue reading to learn about reporting a 1031 exchange and how it unlocks huge growth potential and meaningful investment gains.

How does a 1031 exchange work?

A 1031 exchange is a tax break for swapping one investment property for another. The proceeds are generally required to be held in escrow by a third party until the new property is purchased.

Strict deadlines must be followed for a section 1031 transaction to qualify, so you need to plan ahead. You must identify a  new property to replace the sold property within 45 days, and the sale of the replacement property must be complete and closed within 180 days.

The four primary types of like-kind exchanges 

Delayed Exchange

A delayed exchange allows for the most flexibility. The sale of the original property must be complete before the replacement property is acquired. A third party then holds the funds for up to 180 days while the like-kind property is purchased.

Simultaneous Exchange

The oldest of the like-kind exchanges is a simultaneous exchange, which occurs when the current property sells on the same day as the replacement property.

Built-to-Suit Exchange

Often involving a new construction or ongoing renovations to the property, built-to-suit exchanges allow you to use any excess proceeds towards improvements. This is still subject to the 180-day time frame, in which all changes must be completed.

Reverse Exchange

In the case of a reverse exchange, the investment property is purchased before exchanging the currently owned property. The new property must be transferred to an exchange accommodation titleholder until the sale of the current property is closed.

 

Advantages of 1031 Exchange

The biggest advantage to completing a 1031 exchange is deferring capital gains tax, which is the levy on the profits earned from the sale of an asset —in this case, the real estate property. You can eliminate this tax by deferring your tax liability and managing your 1031 exchange properly. You will also benefit from numerous others, such as:

Depreciation Reset

The federal tax on depreciation recapture when selling a property comes in at a hefty 25%. With a 1031 exchange, the depreciation carries over into the new investment property, deferred until the new property’s taxable sale occurs.

More Buying Power

The tax savings you’ll get from deferring your capital gains tax means there will be more money in your pocket, increased cash flow, and open up more buying power.

Multiple Property Consolidation

Reclaim your time by exchanging a high-maintenance property for easier-to-manage real estate or consolidate multiple properties through a single 1031 exchange.

Portfolio Diversification

Diversify your assets and lower your potential risk with a 1031 exchange. Trade up for a single higher-value property or multiple properties.

A 1031 exchange is a great tool to add to your financial real estate strategy. With the guidance from Lescault and Walderman, you’ll be able to maintain a positive cash flow, save on taxes, and expand your business portfolio. Schedule your free discovery call and take out the hassle of your real estate accounting.