You may have heard of the term 1031 exchange but has not fully understood what it means. The said number simply refers to the Section 1031 of the revenue code, which states that the property owners will not be subjected to capital gains taxes after selling his investment property, provided that he uses the proceeds of the sale to purchase a new investment property. It may sound easy. However, there are a lot of requirements and rules that has to be met before one can take advantage of this.
Purchasing a new investment property:
In order to benefit from this, the owner of the investment property sold has to purchase a like kind property. This property does not have to be identical with the property sold. If you sold an apartment, you do not have to purchase a new apartment for rent. Although this is the case, it has to serve the same purpose. The IRS has a broad interpretation of this term. This property should also be identified 45 days after the closing of the first property. In addition, it also has to meet the the conditions of section 1031.
Who is the qualified intermediary?
He is a middleman. He is often referred to as the QI. After selling the first property, the proceeds shall be given to him. Any amount not given to him from the proceeds shall be subjected to tax. The said money shall be held in escrow until the closing of the second property takes place. Moreover, he should also assist the buyer in all his paper works to ensure a smooth transaction.
Other rules relating to the 1031 exchange:
As previously mentioned, the property owner should purchase a like kind property. This property must have the same or greater debt compared to the first property. In addition, it closing transaction has to be made within 180 days after the closing of the first investment property.
The use of the 1031 exchange:
More and more people are using this to juggle investment properties.
Since they are able to acquire a new property by selling their existing property --free of capital gains tax, they are presented with opportunities to have better investments. Although this can be beneficial, you have to know and comply with the different rules set in the code.
Moreover, you have to let the other parties aware that you are going to use the 1031 exchange. They have to understand why you are entrusting the transaction in the hands of a QI. Notifying them will also make them aware that the law binds them to cooperate. After the transaction is finished, it has to be reported together with the tax
return using the form 8824.
In order for you to benefit from the 1031 exchange, you have to know its conditions first. How are you going to qualify? What are the requirements you have to present? What are the things you need to do to exempt the proceeds of the capital gains tax? Once you familiarize this, it will be very easy to benefit from section 1031.
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