Savvy investors wishing to buy and sell commercial properties should know all about 1031 Like-Kind Exchanges and how they work to save on capital gains taxes. Also known as a tax-deferred exchange, the term has become popular as a verb among real estate professionals: “Let’s 1031 that property for another.”
Beress & Zalkind PLLC is a Real Estate Law Firm with the experience and knowledge to help you with investing, tax saving and other real estate concerns. A 1031 Like-Kind Exchange is a popular tool among real estate investors, and here’s more about how it works.
What is a 1031 Like-Kind Exchange?
“A 1031 exchange is a swap of one real estate investment property for another that allows capital gains taxes to be deferred.” The term gets its name from Section 1031 of the Internal Revenue Code (IRC). It allows investors to defer paying capital gains tax that otherwise would be due at the time of sale. This is accomplished by putting the proceeds from the sale toward another property that is similar in value and nature. Because you recognize no profit from the sale, there is no resulting tax.
Of course, the IRS has rules that govern how 1031 exchanges work, and you should understand these before attempting a 1031 exchange. For example, using this type of exchange for vacation properties is closely limited and there are time frames that can be problematic. A Real Estate Attorney can explain more about qualified properties and other restrictions.
How Does a 1031 Exchange Work?
A 1031 exchange essentially swaps one property for another. New rules under the Tax Cuts and Jobs Act (TCJA) in 2018 placed stricter definitions on the types of properties that qualify. Only real property, or real estate, defined in Section 1031 qualifies. The basics of a 1031 exchange are as follows:
- Determine the Properties to Be Bought and Sold – Section 1031 of the IRS Code stipulates that the properties must be “like-kind;” however, this does not mean they must be the same. Similar properties do not have to be the same type or grade.
- Choose a Qualified Intermediary – The proceeds from the sale must be held in escrow by a third party, then used to buy the new property; you cannot receive them, even temporarily. This third party is known as a qualified intermediary. This is a person or company that agrees to sell the property on your behalf, purchases the new property and transfers the deed to you. The qualified intermediary can have no other formal relationship with you or the parties buying or selling real estate in the 1031 exchange.
- Inform the IRS of Your Exchange – You must file IRS Form 8824 to inform the IRS of your 1031 exchange transaction. This form describes the properties exchanged, identifies the parties involved in the process, lists the monies involved and provides a timeline of events.
Why Should I Consider a 1031 Exchange?
Investors may want to consider a 1031 like-kind exchange for a number of reasons. Of course, the main reason is to defer paying capital gains tax when selling one commercial property and purchasing another. This exchange can occur numerous times to save considerable taxes. Although you may profit from each exchange, you avoid paying the tax until you finally sell and keep the profit. You may buy and sell many times, but you only pay capital gains tax once, and possibly at a much more favorable rate at that time.
Other reasons to consider a 1031 exchange include:
- You wish to diversify your assets
- You wish to consolidate several properties
- You wish to divide a single property into several assets
- You are seeking a property with better prospects for a return
- You wish to benefit your heirs after death
Another significant benefit is that if you die without selling the property obtained through a 1031 exchange for a profit, your heirs can inherit the property and its value is “stepped up” to the market rate, and all deferred taxes are erased.
There are many other ramifications of 1031 exchanges that make them attractive for estate planning, and many nuances to be understood. A seasoned Real Estate Attorney from Beress & Zalkind PLLC can thoroughly explain how 1031 like-kind exchanges work and the best ways for you to use them in your estate planning. Contact us today to schedule a confidential consultation and learn more.