New Jersey 1031 Exchange for Real Estate Properties
WHAT IS A 1031 EXCHANGE FOR REAL ESTATE PROPERTIES?
The Internal Revenue Code Section 1031 provides that no gain or loss will be recognized on the exchange of any business use or investment property for any other business use or investment property. 1031 Exchanges for real estate properties are not an exchange in the context of two-party barter. They are typical sales and purchases involving the same characteristics as any other sale or purchase without capital gains. The only real difference is the investor is increasing his selling and buying power by electing to defer the drain of taxes under Section 1031 regulations. No other aspects of the transaction are affected.
Who Should Consider a 1031 Exchange for properties?
If you‘re selling a business-use or investment property, you should consider a 1031 Exchange. A 1031 exchange offers the educated investor an opportunity to reinvest the federal capital gains that would usually be handed over to the Internal Revenue Service.
Benefits and Advantages of a 1031 Exchange for Real Estate Properties?
Keep in mind that the Cortes & Hay team is always happy to discuss the benefits of taking advantage of a 1031 exchange for your property at any time. Our goal is to help you to make the most out of this tool. Due to the fact that some aspects of it can be confusing or overwhelming, we encourage you to take the time to speak with us in more detail about it. Here are just a few examples of a 1031 exchange:
- Estate preservation
- Buying power increases due to greater cash flow
- Selling power increases because the federal capital gain tax liability is deferred.
- Possibility of increased income.
- Relocation possibilities for business or investment property
- Exchange for a property that requires less management
- Consolidation of smaller properties into larger properties
- Business Expansion possibilities into a larger space
Common Misconceptions About 1031 Exchanges for Properties
Many think properties must be “swapped.” In the original code, this was a requirement but is rarely done today. A 1031 exchange will allow you to sell to one party and buy from another.
Another misconception is that only investors in larger commercial properties are eligible for the benefits of Section 1031. 1031 Exchanges apply to all investment properties, large or small. A Corporation selling a sizeable industrial park can benefit the same as an individual selling a home used as a rental property in a vacation area.
Some think you must acquire “similar use or service” property. The term “like-kind” exchange is often used when describing 1031 exchanges. This applies to real property held for use as a business or investment. For example, you may sell raw land and exchange that with an industrial park or rental apartment building. You may sell one property and purchase three as a replacement. Any real property used for business or investment will qualify.
1031 exchanges are not as difficult as one may be lead to believe. If working with a qualified intermediary that specializes in Section 1031 tax-deferred exchanges, the transaction will be very smooth. A qualified intermediary will keep you apprised of your time deadlines and ensure that all steps are complete in compliance with the Internal Revenue Service regulations.
1031 Exchange Rules You Should Understand
A 1031 deferred exchange is an exchange in which you sell your qualified property called the “Relinquished Property” and subsequently purchase qualified property called the “Replacement Property”.
- The properties must qualify and be of “like-kind.”
- There must be an actual exchange of property, real property for real property, not a property transfer for money only.
- The time requirements must be strictly followed without exception.
Real estate is divided into four (4) classifications for income tax purposes. The Classifications are:
- Held for business use (§1231)
- Held for investment (§1221)
- Held for personal use
- Held primarily for sale (dealer property)
- The first two classifications, held for business use & held for investment, qualify for §1031. The second two, held for personal use & held primarily for sale, do not.
Under §1031, both business and investment property qualify. It does not require only business property for business property or investment property for investment property. You can mix the classifications. For example, you can exchange a rental property (business property) for unimproved land (investment property).
The first time limitation requires a Replacement Property to be identified within 45 calendar days of the transfer of the Relinquished Property. This is called the “Indentification Period”.
The second time limitation is called the “Exchange Period.” The exchange period begins on the date you transfer the relinquished property and ends 180 calendar days later. The exchange must be completed during the “exchange period.”
There are limitations on how many replacement properties you may identify in the same deferred exchange, no matter how many relinquished properties you sell.
- You may identify three (3) properties without regard to the fair market value of the properties; or
- Any number of properties, as long as their aggregate fair market value at the end of the identification period does not exceed 200% of all the relinquished properties, as of the date when the relinquished properties were transferred.
However, there are exceptions to these rules. First, any replacement property you receive before the end of the identification period will be treated as correctly identified, regardless of whether the three property rule and 200% rule are violated.
Second, if the three property rule and the 200% rule are violated, you are still treated as correctly identifying any replacement property that’s identified before the end of the identification period and received before the end of the replacement period. If the fair market value of the replacement property received is at least 95% of the aggregate fair market value of all identified replacement properties. This is referred to as the “95 percent rule”.
Identification of Replacement Property
Replacement property is identified only if designated as replacement property in a written document signed by the taxpayer and hand-delivered, mailed, faxed, or otherwise sent to this office before the end of the identification period.
Completion of 1031 Exchange
You acquire the replacement property, close the transaction before the end of the exchange period, and the replacement property acquired is the same as identified during the 45-day identification period.
The secret to a successful deferred exchange is to avoid receiving money during the transaction.
A 1031 Exchange is not straightforward. There are many steps to the process, and those steps may have a specific order required to comply with 1031 exchange IRS regulations. Our decades of expertise will help you glide through your exchange for a worry-free transaction. Call us today to learn more about what we can do for you.
Do you have more questions about 1031 exchanges or perhaps you’re ready to take advantage of a 1031 exchange for your property? Get in touch with us today for more information.