A 1031 Exchange is a powerful investment vehicle to purchase property. In its simplest form, the 1031 exchange rules allow you to defer paying capital gains taxes on a property. It can also be an excellent investment and estate planning tool.
While the tax-friendly vehicle has been around for many years, the rules have become more restrictive than they once were. To get a better grasp of this powerful tool, here are six steps you can follow to better understand the complexities of 1031 exchange rules keeping in mind that if you have any other questions about a 1031 exchange, we’re happy to answer them.
Step 1: Understand What a 1031 Exchange Is
There are many different ways of explaining a 1031 exchange. A 1031 exchange allows you to exchange real estate used for business or held as an investment solely for other business or investment property that is the same type or “like-kind.” As long as you make a like-kind exchange, you don’t have to pay a gain or loss until you sell the property or dissolve the 1031 exchange.
While it was once permissible to include other property in a 1031 exchange, the IRS will now only permit real estate exchanges. You have to recognize the gain if you receive money or property that isn’t like kind or real property. In this case, you are not permitted to take a loss.
Step 2: Understand What Types of Properties Qualify
Any real estate asset counts as “like-kind” to any other. Both have to be held for business or investment. Your personal residence would not qualify, but any other real estate does, with the exception of real property outside of the United States. It is not considered like-kind.
Step 3: Learn the Time Constraints
The IRS states that you have 45 days from the date you sell your property to identify potential replacement property(ies). After that, you have 180 days from that same date you sold your property to close on your replacement property.
The trick here is to give yourself time and plan accordingly. You won’t want to try doing everything on the 179th day. That’s just asking for trouble! Be as expeditious as you can. It will lead to a smoother transaction from start to finish.
Step 4: Understand How it’s Used as an Investment and Estate Planning Tool
If a property is part of a 1031 exchange, you can defer capital gains tax until you remove the property from the 1031 exchange or sell it. At that time, you would be responsible for all due taxes or you could continue to defer taxes by exchanging properties in the 1031.
A 1031 exchange can become a valuable tool upon your death. Your heirs get the property on a stepped-up tax basis which means they don’t have to pay a capital gains tax on the new valuation. You will have deferred the taxes until your death when your heirs receive the property without having to pay the tax you deferred. In this case, 1031 exchange rules provide a benefit for the next generation.
Step 5: Call the Experts
At Cortes & Hay, we have been helping people with 1031 exchanges for more than 50 years. We have a very experienced team and understand the New Jersey property market and rules. We can help you with the most challenging questions regarding 1031 exchanges in New Jersey. Don’t hesitate to get in touch with us today!