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Welcome to my NEW Video Real Estate Blog! – “What is a 1031 Tax Deferred Exchange?”

by: Jeff Quintin, on July 12, 2010 - Uncategorized

There are three types of 1031 tax deferred exchanges that can take place:

1.) Straight exchanges
—two parties trade properties of equal or approximate value. This is the simplest exchange.

2.) Multi-party exchanges—this involves three or more parties buying, selling, or exchanging properties. Don’t attempt these exchanges without the aid of a tax professional; they tend to be very complex.

3.) Delayed exchanges—this exchange allows the sale of the relinquished property and the buying of the replacement property to occur at different times as long as stringent rules are followed. This is the exchange most often used.

What’s the Advantage of the 1031 in Terms of Taxes?

As the law’s title indicates, the capital gains tax is deferred, but not eliminated. However deferral is a great way to leverage small real estate holdings into larger ones! Since you can postpone gains, you’re able to use a tax-deferred exchange strategy to transfer equity to a larger property, all without paying taxes!

Another advantage is that there’s no limit on exchanges. This means you can make as many exchanges as you want! So, over the course of your lifetime, you can keep growing income and appreciation by adding new properties without having to pay the capital gains tax!

If you specialize in buying and renovating properties and want to keep reinvesting your profits into larger properties, then this strategy is especially attractive.

Note: If you don’t keep reinvesting, you risk being classified as a real estate dealer by the IRS and will not be able to participate in exchanges.

What Are the Basic 1031 Qualification Rules?

There are some basic rules that must be followed in order to qualify for a 1031 exchange. These include the following:

1.) The properties to be exchanged must be located in the United States. Note: You can exchange foreign property for foreign property and domestic for domestic. However, you can’t mix these exchanges together.

2.) You must trade only like-kind real estate.

3.) An exchange must be made that’s equal to or greater in both value and equity. Any cash or debt relief received above this amount is considered “boot” and is taxable.

4.) The like-kind property must be identified within 45 days of the closing on the initial property.

5.) All proceeds from the initial sale must be turned over to a”qualified intermediary” (also called a QI, facilitator, exchanger, etc.) who is the person or company playing the role of middleman.

6.) Any of the proceeds not under the control of the middleman are subject to taxation.

7.) The middleman holds the funds from the initial property in escrow until such time as the closing on the second property occurs.

8.) The middleman also assists the owner with the preparation of paperwork and other services to ensure the transaction progresses in a smooth manner.

9.) The closing on the second property must take place within 180 days following the close on the first property.

Wow, as you can tell, this is pretty complex subject and can’t completely covered here! But if you’re an investor or plan to be one, I hope I whetted your appetite for this subject.

And please, if you have any further questions, feel free to call me! I’d love to tell you more!