A tremendous tax advantage that is often overlooked when buying property is the tax deferred opportunity commonly known as a 1031 Exchange. While the guidelines are very specific, they are relatively simple to manage.
Basically, a 1031 exchange allows the buyer to strategically sell a qualified property and buy another within a specific timeframe. Since the IRS views the transaction as an “exchange” and not a sale, it permits the taxpayer to defer the capital gains tax on the property they sell.
We are seeing more and more clients taking advantage of this opportunity; it is not a complicated process, it just has its own set of ironclad rules.
When can you do a 1031 Exchange?
- If you plan on acquiring a replacement (or what is commonly referred to as a “like kind”) property after selling an existing investment property
- If the total purchase price of the “like kind” property is equal to or greater than the total net sales price of the existing property you are selling
- If all the equity that you receive from that sale is used to acquire the replacement “like kind” property
How are the monies handled?
The proceeds from the sale of the investment property must be held by a “qualified intermediary” and do not get handed over to you or your Realtor. These funds are in a sense “escrowed” pending application to the purchase transaction.
What are the 1031 Exchange Timelines?
There are two:
- The Identification Period – You must identify a selection of other replacement properties that you wish to buy. This period is exactly 45 days from the day that you sell the property; no exceptions.
- The Exchange Period – This period ends exactly 180 days after the date that you close on the sale of the home (or is the due date that your federal tax return for the year in which the transfer of the property has occurred, whichever situation is earlier). This is the time period you have to finalize your new purchase transaction.
Please note that while none of these time frames are negotiable, it is a very clear cut process that can save you an extraordinary amount of money and even adds more appeal to this buyers’ market.