The Important Requirements of a 1031 Exchange
Buying or selling properties does not appear to be complicated. But when talking about tax, what seems easy no longer seems that way. Nevertheless, being familiar with taxes and its many aspects can be an advantage. For example, when you decide to sell your property and purchase another, there are certain tax rules you need to be aware of. If the sale involves two investment properties, it may be suitable for a 1031 exchange.
The 1031 exchange refers to a section in the Internal Revenue Code that talks about transactions involving the exchange of one business or investment property for another. With this strategy, you may sell your income, business or investment assets and have it replaced with a property of the same kind. In this case, you may exchange a shopping center for an apartment or an industrial building. To qualify for this, only like-kind properties that are held for business or investment purposes can be exchanged. Thus, you cannot exchange your residential property for a business property. When you qualify to this type of exchange, you may have the chance to experience a tax deferral. But you should always keep in mind that this method only works when both properties involved are of the same type.
There are certain rules and requirements involved in a 1031 exchange. For instance, you should be aware of the 180-day rule for this type of transactions. From the time you sold your old property, you will only have 45 days to identify potential replacement properties. You should take note that this will include all days with no exemption of weekends and holidays. You can identify up to three potential replacement properties as long as their total value does not exceed the 200% limit. After the 45-day period, you will be given 135 days to purchase any of the potential replacement properties you identified. Before the 180th day, you will have to pass the title of the new property you bought in exchange of the old one.
You are also not allowed to hold the earnings of the sale of your old property. A qualified intermediary will hold the proceeds of the sale in a separate account, at least until you have completed the purchase of the new property. Your third party will also be tasked to prepare the documents required by the Internal Revenue Service at the time of selling the old property and buying the new one. Your family members or business associates for the preceding two years will not be qualified as an intermediary.
Besides the aforementioned requirements, you should also know that the name listed in the titles of the old and the new property should be the same. There are other scenarios involved in 1031 exchanges. To gain better understanding about it, you should consult a CPA or an attorney who have experience in this field.