At NBI Properties, we’re fielding lots of questions from investors interested in the IRS tax code 1031 exchange. This important tax code is attractive to investors because it permits the sale of one investment property to in order to purchase a higher-priced investment property — all without paying capital gains taxes and depreciation recapture taxes. The 1031 exchange is popular with investors because it can be used in multiple ways, according to Craig Barrett, co-founder of NBI Properties.
“By taking advantage of the 1031 exchange, investors can sell properties while taking part of the profits out,” he said. “However, when most of the profit is rolled over into a new property, investors may defer taxes on the amount that is rolled over.”
Since tax codes tend to be complicated and confusing, it’s important to retain a highly qualified real estate broker and tax expert. A few basic guidelines about the 1031 Exchange to consider include:
Properties qualifying for a 1031 exchange must be for business use or investment (“productive use” as descrIbed by the IRS).
Property must be of “like-kind” (also broadly interpreted by the IRS).
A qualified intermediary is required.
The investor cannot have constructive receipt of sale proceeds at any time.
The 45-day identification period and 180-day closing requirements must be met.
Price of the replacement property must be equal to or greater than the relinquished property.
The amount of mortgage on the replacement property must equal or exceed that on the relinquished property.
All of the funds from the sale must be reinvested in the replacement property.
In addition to these general guidelines, many investors consider the time restrictions the most difficult part of a 1031 exchange, and especially if transactions involve commercial real estate. As stipulated in the tax code, investors must identify a replacement property within 45 days of completing the sale of the property they are exchanging for a more expensive property.
The other major requirement is that a Qualified Intermediary must be used. This is a person holding a specific license allowing them to make the financial transactions on an investor’s behalf.
“The entire process sounds overwhelming, but it’s worth it because the tax savings for investors is huge,” explained Barrett.