Internal Revenue Code Section 1031 is one of the single greatest wealth-building tools available to a real estate investor. It allows investors to defer the payment of capital gains taxes when selling an investment property and exchanging it for another investment property.
Why Consider a 1031 Exchange?
- Deferral of taxes. Defer 100% of your capital gains taxes. A 1031 Exchange allows you to sell your investment property and reinvest in a replacement property in order to defer ordinary income, depreciation recapture, and/or capital gains taxes.
- Leverage and increased cash flow for reinvestment. By deferring taxes, you will have more money currently available for investment. This increased purchasing power gives you the extra leverage to acquire, for example, a property or several properties with significantly higher investment benefits than if you sold the original property, paid all the taxes associated with the sale, and purchased a new property.
- Consolidation. If you own a property or several properties burdened with extensive maintenance costs and requiring intensive management, you may exchange and replace the property for others with less responsibility.
- Estate Planning. A common challenge among family members who inherit a large piece of real estate is agreeing on what to do with the property over time. A 1031 exchange provides family members with the opportunity to acquire several properties in exchange for one large property enabling each family member to realize his or her individual investment objective.
Understanding The 1031 Exchange Process
As per IRC §1031, a valid property exchange is the selling of an investment property with the intention of reinvesting the profits into a new property thus deferring capital gains taxes. These transactions allow investors to continue investing in other properties without losing their investment equity to taxes.
If you exchange investment property exclusively for “like-kind” investment property, there is no immediate tax liability thereby making the exchange a desirable option for investors eager to keep the property’s equity for re-investment.
With a 1031 exchange, the replacement property must be identified within 45 days and acquired within 180 days of the sale of the relinquished property. To be eligible for a safe harbor tax deferral, the proceeds must be held by a qualified intermediary between the time of the sale of the relinquished property and the purchase of the replacement property.
Step 1: Selling the Property
The Beacon Group will inform you of available exchange options and recommend which option best suits your specific goal.
We will prepare and organize the required documentation you will need to complete, and an exchange specialist will notify you of important dates during the exchange process.
Step 2: Identifying a Replacement Property
The Beacon Group will prepare all necessary forms.
IRC §1031 requires that identification of a replacement property take place within 45 days (see Rules and Timelines for details on the Identification Rules).
Step 3: Purchasing a Replacement Property
With the guidance of an exchange specialist, you will purchase the replacement property within 180 days of the sale of the relinquished property. Beacon will transfer the proceeds from the sale of the relinquished property to your escrow company and upon closing, you will receive the deed to the replacement property.
There are several types of exchanges: Simultaneous, Delayed Exchange, Reverse Exchange, Improvement Exchange, and Personal Property Exchange. The Beacon Group has expertise in all types.