1031 Tax Exchanges
The Tyson Group is ready to help you with your next 1031
tax exchange. We specialize in putting buyers and sellers together for 1031
exchanges and have a combined 40 years experience in selling commercial and
residential real estate in New Bern and Eastern N.C.
The following information is presented to give you a general idea
about the IRS 1031 program. Any specifics regarding 1031 should be discussed
with a CPA or a tax attorney.
The 1031 Tax Exchange
One of the reasons that real estate is such an attractive investment is that you do not pay Social Security or Medicare taxes on unearned( rental or capital gain ) Income.
Another reason real estate can be attractive to investors is because the IRS 1031 exchange program allows you to defer paying taxes on capital gains which occur when you sell real estate for a profit.
Trading or exchanging property has gone on for many years but there were no clear IRS rules on how those transactions would be taxed. That all changed in the summer of 1990 when the I.R.S. finally came out with the long awaited rules on Deferred Exchanges.
Section 1.1031 of the Internal Revenue Code laid out in detail the procedure for turning a sale and purchase type transaction into an exchange.
Please note that private residences do not qualify under this program. The 1031 program pertains to property held for investment (raw land), to produce income, or used in a trade or business.
It is important to understand
that I am a real estate broker and not a licensed CPA or attorney.
Please consult with those professionals to verify the tax and legal information contained
in this webpage. My goal is simply to make individuals aware of
an IRS program that could potentially defer
taxes on the capital gain that is realized from the sale of investment
Why would someone want to
exchange property instead of just outright selling the property? There are many
reasons, listed below are a few:
1. To defer paying capital
gains on the sale of a property.
To exchange for an investment
property located closer to your new home or in a different area.
3. To move from one type
of investment property into another. An example would be moving from
residential investment property to commercial investment property.
4. To exchange fully
depreciated property for non-depreciated property to take advantage of the tax
break on depreciation.
5. To exchange older for newer
rental property to reduce maintenance expenses.
Although the 1031 program
is often referred to as a tax-free exchange, it is actually
a tax-deferred exchange. Uncle Sam is not going to let
you off the hook entirely. However, at present he is willing to let you postpone
the tax obligation indefinitely. Before we delve into the 1031 program, the
following are a few terms of which you should be fully aware in order to
understand the program.
A taxpayer is required to pay taxes on both earned income and unearned income.
Earned income is the salary or commission you earn from your employer.
Unearned income can be one of four kinds. They are the following:
3. Rental income
4. Capital gain income
What is a capital gain?
If you purchase,
inherit, or receive as a gift an asset and sell the asset, you will
probably incur a capital gain or a capital loss. A capital gain will be
taxable. If instead of a reaping a profit you incur a loss, the capital
loss is tax deductible. An exception to this is the case when someone
inherits property. In that case, the first $1 million is exempt from
capital gain, should the heirs sell the property.
There are two kinds of capital gains.
1. Long-term Capital Gain occurs when an asset is held for one year
or longer. Currently the rate for long-term capital gain is 15% for most
tax brackets, which is much lower than ordinary income tax for most
Short-term Capital Gain occurs when an asset is held for less
than one year. Short-term capital gains are taxed at ordinary income
The 1031 Tax Free Exchange
Section 1031 of the Internal Revenue Code states:
No gain or loss shall be recognized on the exchange of
property held for productive use in trade or business,
or for investment, if such property is exchanged solely
for property of like kind, which is to be held for
productive use in trade or business or for investment.
Investment property could include apartments, raw
land, rental homes, or office space.
Property used for productive use could include
machinery, business equipment, etc.
Please note that private residences do not
qualify under this program.
Types of 1031 Exchanges
1. The simultaneous exchange: This occurs when you sell
and purchase properties at the same time.
The delayed exchange: This occurs when you sell
a property and delay (up to 180 days) purchasing another
Reverse 1031: This occurs when you buy a property
and later sell your already identified exchange
The Identification Rule
relinquished property must be exchanged for other
property, rather than sold for cash and using the
proceeds to buy the replacement property. Most deferred
exchanges are facilitated by qualified intermediaries,
who assist the taxpayer in meeting the requirements of
Prior to closing on the property you own, you must
demonstrate your intent to pursue an exchange. This is
done with a form that must be completed and turned over
to your 1031 trustee.
Starting on the day the property or properties you
intend to exchange are sold (closed), the proceeds of
the sale must go directly to and be held by a 1031
trustee. If you take possession of the funds, you lose
the opportunity for an exchange. Within 45 days
from the closing date on the sold property, you must
identify at least one potential replacement property.
Failure to identify a new property or properties within
45 days will result in losing the tax deferment
on the sold property.
If you are not sure what property or properties you want
to buy within the 45 days, you can identify more
than one property and figure it out later. How many
properties can you identify? There are several rules
that determine how many properties you can identify.
These rules are beyond the scope of this webpage and
you should consult with your CPA or attorney to
determine the best avenue for you to take.
You will have a total of 180 days to close on the
property or properties you have identified. The 180 days
includes the 45 days you were given to identify a
are listed a few general guidelines to follow in
order to defer all of the taxable gain on your
Make sure that the value of the replacement
property is equal to or greater than the value
of the relinquished property.
The equity in the replacement property must be
equal to or greater than the equity in the
The debt on the replacement property must be
equal to or greater than the debt on the
All of the net proceeds from the sale of the
property must be used to acquire the replacement
Investing in real estate can yield high returns if you
pick the right properties. Always consult with an
experienced realtor to make sure you are getting the
most bang for your buck. And check with your CPA or
information on 1031 tax exchanges. I hope you have
enjoyed this article. Please send me your comments.
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