1031 Exchange Transaction

Do you own an investment property and thinking about selling it and buying another property? If yes, you should know about the 1031 tax-deferred exchange. This procedure allows the owner of investment property to sell it and buy property while deferring capital gains tax.

On this page, you will find a summary of the key points of the 1031 exchange and its rules, concepts, and definitions. This will help familiarize you with a section 1031 transaction before utilizing it.

What is a 1031 Exchange?

1031 exchange takes its concept from the section 1031 of IRS code. This code will allow you to avoid paying taxes on capital gains when selling your investment properties. It will also allow you to re-invest your proceeds that you gain from the sale within a specific time limit into a similar property or you can invest the money in property of equal as well as greater value.

The Role of Qualified Intermediaries

According to section 1031, whatever proceeds you receive from selling your property will remain taxable. For that reason, you must transfer proceeds from the sale to a qualified intermediary rather than the property seller. The qualified intermediary transfers proceed to the seller of the replacement property or properties.

A qualified intermediary is a person or company that agrees to facilitate the 1031 exchange by holding the funds involved in the transaction until the transfer of funds to the seller of the replacement property. The qualified mediator will not be allowed you enjoy any other formal rapport or relationship with parties involved in exchange of property.

When You Want a 1031 Exchange

If you are an investor, you must consider several reasons why utilizing 1031 is a good option. Some of those critical reasons are:

You may want to buy real estate that has better return potential or if you wish to to diversify your assets.
As an owner of real estate investment properties you may want to look for a managed proper instead of managing it yourself. ,
If you wish to consolidate all your properties in multiple locations into a single entity, you do so. Plus, you can even divide a single real estate into multiple assets.
Reset your depreciation clock

One of the main benefits of using 1031 exchange is tax deferral. So instead of simply selling your property and buying a new one, 1031 allows you to defer your tax from capital gains. Thus you manage to free more of your capital to invest it in your replacement property.

It is vital for you remember that using a 1031 exchange may require you to pay comparatively higher minimum investment about and holding time. This will make your transactions more ideal if you have a higher net worth. Therefore, due to its complex nature, it is always a good idea to hire a finance advisor with expertise in 1031 exchange dealings and transactions.

What Is Depreciation and Why Is It Important to a 1031 Exchange?

Depreciation is a concept that you must understand if you wish to know the true perks of 1031 exchange. It represents the percentage of the total cost of your investment property that you write off every year. Depreciation is all about recognizing the impact of wear and tear on your property.

When you sell a property, the calculation of your capital gains tax take your property’s net-adjusted bases into account. This will reflect your properties original purchasing price of your real estate. Additionally it will also reflect improvement in your capital minus all depreciations.

If you sell a property for a price higher than the depreciated value, you will most likely need to recapture its depreciation. This mean, your depreciation amount that you recapture will increase with time and you may feel motivated to leverage 1031 exchange.

Doing this will also help you avoid any large increment in your taxable income. The increase be the result of recapturing of depreciation later on. This recapture of depreciation is one of the factors that may play a critical role when you calculate your actual value of using 1031 exchange in a transaction.