1031 Exchange Explained
Tax Deferred Exchange Rules and Requirements
Nov 20, 2009 Tiffany Brunskole
If a person truly wants to reap the rewards of a 1031 exchange it is necessary for him to completely understand the rules and requirements for the tax deferred exchange. A tax free exchange can a be a great way to buy and sell properties and come out way ahead in the long run, but is must be done exactly according to the rules or there may be consequences.
What is a 1031 Exchange?
Before a person can even figure out if he will benefit from a 1031 tax exchange, he must know what it is. Basically it is the exchanging of property of equal or greater value and not having to pay taxes on the exchange. A tax deferred exchange looks exactly like a sale on the properties, but works as an exchange that can’t be taxed. There are several 1031 exchange rules that must be followed for this type of exchange to be classified as tax deferred.
1031 Exchange Rules
One of the biggest 1031 exchange rules that must be followed is that the property being sold has to be equal to or lesser than in value than the new property being obtained. This means if a business has a piece of land worth $50,000, they can only do a 1031 tax exchange on another property that is worth $50,000 or more. There are absolutely no exemptions from this 1031 exchange rule.
Another rule that goes along with a tax free exchange is that the whole deal must be done in a specific period of time. A person must identify a new piece of property that he is going to buy no later than 45 days after the close of the sale on the original property. Furthermore, the sale on the new property must close no later than 180 days after the closing on the old property that the person sold. These specific time periods do include weekends and holidays, so an investor must realize that even if the 181st day is on a Sunday and the closing is happening on that Monday, the 1031 exchange is no longer valid.
Lastly, anybody who is performing a 1031 tax exchange must have a Qualified Intermediary hold the money from the sale of the first property until the person buys the new property. An individual is not permitted to hold onto the money himself. The QI also will keep track of the paperwork and the deadlines so that the individual knows how much time they have and what exactly needs to be done to have a successful tax deferred exchange.
Properties That Qualify for a Tax Deferred Exchange
There are only certain properties that qualify for a tax deferred exchange. The properties must be used for productive purposes in a business or investment. The types of properties that may qualify for the 1031 property exchange are business buildings, commercial land, storage buildings, and some residential homes. The only way that a residential home could qualify for the tax free exchange is if it is used for investment purposes, such as a landlord renting it out or a company or individual coming and flipping the house and then selling it to make a profit.
Benefits of a 1031 Exchange
The biggest benefit of a 1031 exchange is that a person can save tons of money not having to pay taxes on the sale or purchase of the new properties. For some people this may mean saving hundreds or thousands of dollars but for other large companies and entrepreneurs it may mean saving millions of dollars. When a person saves this much money he can use that money that would have gone to the taxes on the sale to invest it in other places in the business.
Although a tax free exchange can get rather complicated, it is worth it in the end run to save all that money on the deal and not have to pay anything in taxes. If an individual is unsure on how to go about performing a tax deferred exchange, there are companies that will manage and guide the person the whole way through the process for a fee. One must decide if the company’s fees will be less than the taxes they would pay to determine if it is worth it. The best thing any business person can do when it comes to 1031 exchanges is to read up and learn all the intricate 1031 exchange rules and requirements so that a successful exchange without any hassle can happen.
Resources:
Save Money With a 1031 Exchange
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Only Certain Properties Qualify for a 1031 Exchang
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