The Internal Revenue Code 1031 provides real-estate investors with an excellent tool known as 1031 exchange. So what does it exactly do? It enables investors to hold the profits that they have made from investing in numerous real-estate properties without paying any tax on the gains. That sounds too good to be true right? So, you might be wondering what is the catch? The truth is there isn’t any. A 1031 tax deferred property exchange allows investors to reinvest in the proceeds coming from selling like-kind real-estate investments. The 1031 exchange process comes with a similar reputation to that of a calculus; there is a lot of work involved, however, it is not quite easy to comprehend. We are here to break it down to you in a simple form. In this article, we are going to talk about the salient features of the 1031 exchange to know if it is the right investment choice for you.
The first thing to know is that there are few restrictions involved on the investments that qualify for an exchange. The property you sell and the replacement property you invest in must meet some specific guidelines. Both the properties must be held for use in a business/trade or any kind of investment. One thing to note here is that a personal-use property does not qualify here. Also, both the properties must be similar enough to be termed ‘like-kind'. For instance, the real estate properties that are enhanced with a residential rental house are like-kind to a semi or fully vacant land.
Furthermore, it is essential to note that 1031 tax deferred property exchanges are, as you can tell by the name, tax-deferred and not tax-free. As there is no such thing as free lunch, there is also no such thing as a tax pass. The basis by which a property is acquired in a 1031 exchange is also the basis by which you sell the property, albeit with some adjustments. While you transfer the basis from one property to another, you have the upper hand to recognize it at a later stage. You can say that you have frozen the gains in time. It is highly essential to track, as well as adjust the basis in the correct way to make sure you fully comply with the guidelines stated in Section 1031.
The great news is that you can defer the taxes forever. Yes, you heard that right! There are no restrictions on the 1031 exchanges that you can undertake. You can rollover the deferred gains on any investment property again and again. With the right property estate planning, you can finally pass on the real estate investment gains to your heirs or your loved ones.