Many investors struggle to determine what exactly a 1031 tax exchange is! Usually, investors are not familiar with the time limits, restrictions, different structures and qualifications of a 1031 exchange. Anyone associated with real estate investing should be informed about tax-deferred exchanges (from tax advisors and lawyers to real estate and closing agents and lenders).
Lack of knowledge and some misconceptions about the advantages of exchange transactions can lead to unnecessary payment of capital gains taxes. For that reason, clients should be introduced to the benefits of 1031 exchange tax.
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Getting Into 1031 Exchange Section
The 1031 Exchange is found in the Internal Revenue Service code. It entitles investors to capital gains taxes deferral for business or investment reasons. Capital gains taxes are not included in the property trade in cases where the money are applied to another property contract. The tax payment may be deferred until the sale of the property.
What’s interesting about this tax code section is that when you sell a property in order to purchase another one, there is no additional capital gain. There has only been a shifting of one property to another.
For instance, when an apartment building is sold in an exchange for another one, the real estate investor won’t be charged for capital gains (under the right criteria).
The seller of a real estate will be able to defer capital gains of real estate investment properties in cases when:
- The property is operated by business or investments
- The property is traded through a 1031 exchange
- The replacement of the property is acquired within the appropriate timespan
Taxes may be deferred when the taxpayer sells the relinquished property and subsequently obtains a replacement property. If all the rules are respected, then the transaction will be regarded as an exchange rather a sale-purchase.
The taxpayer should not hold onto the funds intended for the exchange after the closure of the relinquished property. Even if the taxpayer agent holds the funds or if the investor can control the arrangement of the funds, then this can be regarded a profitable receipt of the funds. Therefore, a tax can be assigned.
For a successful exchange, it is crucial to be active in both the relinquished and the replacement property.
1031 Exchange Tax Essentials
When starting a new business investment and planning a strategy, you need to be aware of the rules (and follow them). A 1031 Exchange tax can be quite a complex strategy, so seeking professional assistance is advisable. In order to enjoy great wealth, you need to have the right support available to you.
Westwood Net Lease Advisors are always at your disposal when it comes to commercial real estate sale-purchase or exchange deals. We can advise and guide you throughout the whole investment process.
Using The 1031 Exchange Offers Many Advantages:
● Unlimited Tax Deferral
Huge tax deferral may be considered as one of the most appealing benefits. As there is no time limit on tax deferral, you will be free to transfer the taxes to the replacement property numerous times. You are always allowed to consult with Westwood Net Lease advisors to guide you through this engaging strategy.
● Less Engagement
Active management is one of the most nagging issues in commercial real estate investment. However, by using 1031 exchange you are allowed to defer the taxes while minimizing your management responsibilities. Management can be very a time-consuming and exhaustive process, so a 1031 exchange may be the solution for you.
With exchange opportunities, the investors can exchange a property for one, or multiple other properties. Another option is that the investor joins multiple properties into one, and buys a new property wherever the investor wishes (throughout the USA). For example, an investor may choose to exchange a duplex for an office or exchange one property in Minnesota for two in Wisconsin. There are options.
● Stronger Cash Flow
Tax deferral strategies can be money-saving and can also help you expand the rate of cash flow. This is a compelling reason to consider a 1031 exchange, allowing you to obtain more money and consequently invest in other ventures. A 1031 Exchange brings a useful marketing tool to agents as well.
You can buy a new property and acquire more income.
1031 exchanges bring outstanding cash flow as well as greater net worth. It is more beneficial to utilize a 1031 exchange rather than pay taxes each time a sale takes place. You can exchange various types of commercial real estate properties throughout the years and those exchanges could be handed to someone else in the future.
When And Where To Seek Professional Assistance
The 1031ofxchange in the Internal Revenue Code slowly becomes a well-known tax tool among realtors.
Switching one property asset with another one has become so common, that it is important to understand the rules and procedures for a successful tax exchange.
Here are some of the things you should consider when looking at a 1031 exchange.
● You cannot use it for personal purposes
The provision that is gained from the exchange is intended only for investment and business properties. There is no option of switching your main residence to another apartment. However, there is a possibility where you can use 1031 exchange tax for switching dwelling houses.
● Personal Non-Real Estate Properties may be eligible
Usually, 1031 exchanges are associated with real estate. However, some personal properties (let’s say furniture or jewels) may also be eligible. Corporate stocks or partnership interests though cannot be qualified. On the contrary, tenants’ interests in real estate do qualify.
● Like-kind exchange
When mentioning exchange tax properties, we may apply the term like-kind exchange as well. But what does like-kind property mean? It refers to two property assets that belong to the same type (e.g two industrial assets), but not always the same quality. To illustrate, apartments may be subject to raw land exchange or one business for another. There is no strict rule. Yet, you should be aware and careful of traps that could disqualify an exchange (if any).
● Postponed Exchange
Traditionally, the exchange is lead by two people by swapping two like-kind properties. Still, it can be quite challenging to find two similar properties. That is why most of the exchanges are postponed to a later date. Accordingly, a third party (a middleman) will be involved. The third party will detain the money after ‘getting rid of’ the property and will use the money to acquire a substitute (a replacement property).
● Selection of replacement property
In a postponed exchange, it is crucial to select a replacement property. The third party will receive the money immediately after the sale of the property. You are not allowed to receive the cash, as it will affect the 1031 exchange. You must select a replacement property within 45 days of the sale and pass it in a written document to the third party, stating clearly the type of property you want to get.
● Mortgages and any other debts
Many investors disregard loans when making a transaction. However, you should not neglect mortgages or any other debts on the property you are about to give away, as well as any debts on the replacement property.
It is very important to be informed about the rules for 1031 exchanges as you may be charged for taxes or penalties. Taxpayers should be careful of anyone who tries to encourage the unprofessional use of like-kind exchanges.
Many sales presentation look on like-kind exchanges as tax-free, rather than tax-deferred. To avoid these unpleasant circumstances, please do not hesitate to ask for professional help from our Westwood Net Lease Advisors.
We can give you the necessary information and offer you additional assistance with 1031 exchange (as well as guide you throughout the whole investment process).1031 exchange, 1031 tax exchange, 1031 tax exchange rules, commercial real estate, commercial real estate investing, Commercial Real Estate Investment