Section 1031 Tax Exchange: Why is it Important to Consider?
Section 1031 Tax Exchange
For real estate investors and business property owners, the 1031 Tax Exchange can be an effective tool when buying and selling investment property. Section 1031 Tax Exchange of the Internal Revenue Code (IRC) allows investors to defer capital gains tax or “carry-over” taxes from the sale of their former property and reinvest the proceeds into one or more replacement properties. In other words, investors are “exchanging” one property for another while deferring federal tax obligations.
When typically selling business or investment real estate property, the seller would have to pay a tax on any capital gains received from the sale. The 1031 Tax Exchange is a wise investment strategy that should be considered not only by property owners, but also by professionals who are advising investors such as brokers, accountants, lawyers, or any additional party involved in these types of transactions.
How We Can Help
Whether a corporation or small business, our investment process is simple and specific to your goals. Momentum offers a wide range of investment solutions, as well as services directly related to 1031 Tax Exchanges.
For Sellers
Momentum provides an array of services for those looking to sell commercial property and benefit from the 1031 exchange. Our experts can connect sellers to qualified professionals, identify potential buyers, manage property disposition, and more.
For Buyers
Momentum can help buyers identify and acquire their ideal replacement property(ies) and connect them with qualified third-party professionals best suited to their needs. Learn more about services or connect with one of our agents below.
Basic Requirements and Qualifications
To successfully execute the 1031 Tax Exchange process, you must follow certain requirements set in place by the Internal Revenue System (IRS), including the following:
The entire value obtained from selling your former or relinquished property can only be used for purchasing the replacement property or properties.
Both relinquished and replacement properties must qualify as investment or business property and be used as such.
A qualified intermediary must be involved in the 1031 Tax Exchange process and prepare the required documents accordingly (Exchangers cannot act as their own intermediary).
To qualify for the 1031 Tax Exchange, the replacement property must be considered “like-kind” property, valued equal to or greater than the exchanger’s relinquished property.
Like-Kind Property
Investment property or commercial space used for business, income, or investment purposes is considered to be like-kind property. A personal residence such as a primary or second home does not qualify for the 1031 Tax Exchange.
Like-kind property types:
1031 Tax Exchange Timeline
Overall, the 1031 Tax Exchange process takes place over a maximum of 180 days, which is referred to as the Exchange Period. Within this time frame, the exchanger has 180 days from either the closing date on their former property or the yearly tax return due date (depending on which takes place first) to obtain their replacement property.
However, before acquiring the replacement property the exchanger must complete the Identification Period. The Identification Period is the first 45 days of the 1031 Tax Exchange process where the exchanger must identify their replacement property or properties. By identifying the replacement property, the exchanger will notify the intermediary, who will obtain written documentation, signed by the Exchanger. If the required steps are not taken within either the Exchange Period or Identification Period then the exchange could be voided.
Property Identification
3 Property Rule
The exchanger may identify and obtain up to three replacement properties during the 1031 tax exchange process. Typically, the 3 Property Rule is the most common approach taken by investors.
200% Rule
An exchanger may use the 200% rule to identify more than three properties in the 1031 tax exchange process. The exchanger can identify and acquire multiple replacement properties, as long as the combined property value doesn't exceed 200% of the relinquished property’s market value.
95% Rule
One of the most uncommon approaches taken by exchangers is the 95% rule. The rule allows the exchanger to identify and acquire any number of properties where the value exceeds 200% of the relinquished property sale price. This can only take place if the exchanger can obtain 95% of the property values that were identified in the identification process.
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