1031 Tax-Deferred Exchanges: What are the benefits and considerations?
What is a Delayed Exchange?A Tax Deferred Exchange is one of the few tax shelters remaining. Its use permits a taxpayer to relinquish certain investment property and replace it with other like-kind investment property without triggering capital gains liability. Thus the owner has additional capital available for the purchase of the replacement property, which otherwise would have been paid in taxes. Payment of the tax on the gain is deferred until the final replacement property is sold.
A number of requirements are imposed including specific time periods for completion of the exchange. The taxpayer must identify the replacement property within 45 days and close the purchase of the replacement property within 180 days (or the date of filing tax return if earlier) of the closing of the relinquished property. Also, the taxpayer cannot receive any proceeds from the sale of the relinquished property, actually or constructively without triggering a taxable event. Thus, if the replacement property is to be purchased subsequent to the sale of the relinquished property, all money must be held by a Qualified Intermediary.
Advantages and disadvantages of a 1031 Exchange
The primary advantage in performing a 1031 Exchange is that, through the deferment of capital gains taxes, the Exchangor is able to acquire more valuable and/or more leveraged investment property. If it is the intent of the taxpayer to reinvest the proceeds from one property into another, the 1031 Exchange remains the only vehicle remaining for full tax deferment.
The disadvantage is, of course, that funds must remain invested. There is also the additional cost of the transaction, which is the exchange fee.
What are the qualifications of like-kind property?
It is important when identifying a replacement property to choose like-kind property. Like-kind refers to the intended purpose of the property rather than the exact description of the property. A definition of like-kind property would be real property held for investment purposes, trade, or business. Therefore, the exchange of a rental house for a retail center is considered like-kind.
The tax code specifically lists properties that are not considered like-kind.
These include:
- stock in trade or other property held primarily for sale;
- stock, bonds, or notes;
- other securities or evidences of indebtedness;
- interests in a partnership;
- certificates of trust or beneficial interest.
Also, the property must be in the United States.
Ask me for our PDF "What you Need to Know to SEt up a 1031 Exchange".