Seasoned real estate agents are always looking for ways to capitalize on real estate investments. Similarly, homeowners often try to find a way to relocate to a new property without incurring unnecessarily high costs.
Maybe you want to relocate your vacation house because you have moved to a different area, but you are worried about the taxes that you might have to pay. Here we discuss the advantages for people looking for more information about a 1031 Exchange and the rules and regulations associated with the exchange.
What Is A 1031 Exchange?
A 1031 Exchange is a way to “exchange” properties and defer the payment of capital gains taxes for the sale because the funds will be used to make another similar property. A 1031 exchange is also known as an IRS Code Section 1031. The bill was passed in 1921 and encouraged reinvestment by providing the facility to avoid taxation for the ongoing investment of similar property.
5 Rules for 1031 Exchange
1. Like-Kind Property
Based on the information from the IRS, the property must be “of the same nature or character, even if they differ in grade or quality.” It means that the two types of real estate must have the same purpose.
2. Same Taxpayer
The name on the property sold and the property purchased need to be the same. A 1031 exchange does not apply if the property purchased is under a different name than the one sold.
3. Business Or Residential Property
You cannot exchange your residential property for commercial property or the other way around. If you have a commercial property, you must exchange it for another commercial property.
4. Equal Or Greater Value
You can qualify for a 100% tax deferment with a 1031 exchange if the net market price of the estate you purchase is more than the one you sell.
A valid 1031 exchange example:
- Property selling price: $ 630,000
- Property buying price: $ 690,000
An invalid 1031 exchange:
- Property selling price: $911,000
- Property buying price: $700,000
5. 1031 Exchange Schedule
You have 45 days starting from the first day to choose three possible replacement properties. The chosen properties must satisfy the above conditions to be valid for a 1031 exchange tax deference. Within 180-days, the property must be sold and the replacement property should be under your name to qualify for the tax deferment.
What Are The Advantages of a 1031 Exchange?
One of the obvious advantages of a 1031 exchange for reinventors is the tax deferral. The main advantage is that you can postpone payment of taxes until you sell it or exchange it for another. It is especially beneficial when you look at what you can achieve with this technique because it opens up the added advantage like the following:
Market Conditions Exchange
As the current market conditions stand, homeowners and property owners are always worried about the value of their property. With the help of a 1031 exchange, property owners of class C estate (property older than 30 years) can exchange it for a well-balanced class A real estate (newer well-maintained property). Property owners can move their capital investment to minimize risk, similar to a stock investor shifting funds from live stocks to S&P.