Savvy real estate investors know that a 1031 Exchange is a popular tax tactic enabling them to expand their holdings and boost net worth more quickly and effectively than they could have otherwise. What exactly is a 1031 exchange, and how does it operate?
A 1031 exchange, or a “like-kind exchange,” enables investors to defer capital gains taxes by reinvesting property proceeds into another property, enhancing portfolio expansion and tax planning for real estate investors.
Following the steps listed below will give you comprehensive knowledge of 1031 Exchanges.
Check out this blog post for additional details on 1031s for business assets.
What Is Section 1031?
A 1031 exchange is a swap of investment property, allowing tax-deferred growth without cashing out or recognizing a capital gain. It will enable rolling over gains from one piece of real estate to another, with no limit on frequency.
The IRS sees this as a long-term capital gains rate, currently 15% or 20% depending on income, and 0% for some lower-income taxpayers.
Here are various steps to understand the Rules for the 1031 exchange:
1. Know How the IRS States a 1031 Exchange
Section 1031 of the Internal Revenue Code allows like-kind exchanges of real property for similar property. This strategy was introduced in 1921 to avoid taxation on ongoing property investments and encourage reinvestment. Real estate investors are only required to recognize gains or losses if they receive other similar property or money.
Find Eligible Properties for a 1031 Exchange
The Internal Revenue Service (IRS) considers real estate property like-kind if it shares the exact nature or character as the one being replaced, regardless of how it is improved. The Tax Cuts and Jobs Act of 2017 eliminated personal and intangible property from tax-deferred exchanges but created an Opportunity Zones incentive to encourage long-term investments in low-income areas.
Real estate investors can perform 1031 exchanges to defer capital gains tax or eliminate them through estate planning. However, if not followed, investors may be liable for capital gains taxes. The 1031 Exchange rules have a strict timeline and require the assistance of a qualified intermediary.
Four Possible Structures for Transactions.
Since requirements fluctuate based on specific situations, real estate investors typically employ five distinct types of 1031 exchanges:
A delayed exchange in which a property is sold, and property (or properties) are purchased within 180 days.
Simultaneous exchange, in which the two transactions take place simultaneously.
Reverse exchange with a delay: the replacement property is purchased before the original property is sold.
Delayed build-to-suit exchange, with the money raised going toward funding the construction of a new property customized to the investor’s specifications.
The guidelines for the 1031 exchange remain applicable to real estate investors, regardless of their decision.
Work to Remove Capital Gains Tax Permanently
By delaying the accumulated capital gains tax payment, 1031 exchanges help save money in the long run. However, what occurs if the real estate speculator dies? Real estate is revalued or stepped up to its fair market value when it is bequeathed to an heir, and any deferred capital gains taxes are waived. This highlights how only partially true the proverb “Nothing is certain except death and taxes” is!