Advanced tax planning can allow certain tax liabilities to be deferred. Under Section 1031 of the Internal Revenue Code enables the owner of some types of property to postpone federal taxes that are owed on the loss or gain on the sale of that property by purchasing a similar qualified property.
What Is a Section 1031 Exchange?
A 1031 exchange is often called a tax deferred exchange. It’s a transaction where the owner of a property sells that property but immediately acquires a new “like kind” property. Because the new property is being acquired right away, this transaction isn’t treated like a simple sale and purchase. The Internal Revenue Code considers it an exchange, which enables the property owner to defer paying taxes on any capital gains received from the sale of the original property.
For example, say an owner sells a piece of property for $500,000. The owner’s tax basis in the property is $375,000. Without a 1031 exchange, the owner would have to report a $125,000 capital gain, which would then be subject to federal tax laws. Federal taxes on capital gains can be as much as 30%, meaning that in this case, the owner would owe $37,500 in taxes. However, by replacing the property sold with a “like kind” property, the owner can defer paying those taxes on the gains received until that property is sold.
Who Can Get a Section 1031 Exchange?
Section 1031 exchanges are ideal for businesses, individuals, and other entities who want to sell business or investment property and plan to purchase replacement property. Under federal tax law, as long as the replacement property qualifies as “like kind,” capital gains aren’t yet subject to taxation.
Why Get a Section 1031 Exchange?
If you own property and are planning on selling that property and purchasing new property, you’ll want to consider the benefits and drawbacks of a 1031 exchange in your particular situation. There are many reasons a 1031 exchange can be beneficial for both individuals and businesses, including but not limited to:
- Providing investors with additional leverage to purchase higher value property. Down payments can be increased with the money saved on taxes, boosting buying power for the replacement property.
- Allowing property owners to diversify or consolidate as needed. Owners can exchange multiple properties for one single property, or exchange one single property for multiple properties.
- Increasing overall cash flow. Property owners can increase their cash flow and total income by utilizing a Section 1031 exchange. For example, if an owner’s current property isn’t generating revenue, they can exchange it for another property that will.
Types of 1031 Exchanges
There are three types of 1031 exchanges:
This type of 1031 exchange is largely self-descriptive. With this type of exchange, the timing of the sale of the original property and the purchase of the replacement property must occur at the same time, or simultaneously.
If the idea of having a replacement property ready to purchase exactly when your current property sells makes you nervous, a delayed exchange may be a better option. The replacement property must be identified no later than 45 days after the original property has sold or transferred. The purchase of the replacement property must be completed no more than 180 days after the original property has sold or transferred.
If you acquire your replacement property prior to the sale or transfer of your original property, you may be able to get a reverse exchange. This process is generally more complex than either simultaneous or delayed exchanges and involve the need for an Exchange Accommodation Titleholder (EAT). Replacement property must be identified in 45 days or less after the replacement property’s title is transferred to the EAT, and the transaction must be completed 180 days or less after the transfer to the EAT.
1031 Exchange Timelines
Exchange timelines are important to understand because they play a significant role in whether or not a capital gain from the sale of a property will be considered taxable or not. Here’s what to know about the 45 and 180 day time frames for 1031 exchanges.
Identification — 45 Days
During the identification period, the property seller will identify other “like kind” properties that they would like to purchase. In some cases, more than one property may be selected. The potential replacement properties must be identified no later than 45 days after the sale of the original property, even if the last day falls on a weekend or holiday.
Exchange — 180 Days
During the exchange period, the property seller will receive the “like kind” property. The transaction must be completed 180 days or less after the original property was sold, or, the due date for the property seller’s tax return for the year the exchange occurred — whichever is earlier. Like with the identification period, if the 180th day falls on a holiday or weekend, the timeline is still not extendable.
When to Contact an Experienced Tax Attorney
If you are an individual or a business and you’re planning to sell your current property and quickly purchase a “like kind” property, a 1031 exchange may be an excellent way for you to save tens of thousands of dollars on federal taxes on your capital gains.
Michael J. Krus is a seasoned Orlando tax attorney who can help guide you through the exchange process. He is dedicated to providing his clients with comprehensive legal assistance and will go over every option to determine the best fit for your situation. Contact Attorney Krus today for a consultation to learn more about Section 1031 exchanges or if you have other tax planning questions. Call now at (407) 488-2801.