Have you heard of a tax-deferred Section 1031 transaction? Do you own business or investment property that has gone up in value? Would you like to acquire a new property? If you sell the old property, you’ll have to pay tax on your profits. Don’t do that. Instead, do a tax-deferred Section 1031 transaction.
With a properly constructed Section 1031 transaction, you
- sell your old property,
- buy the replacement property, and
- pay no taxes.
Overview
In practice, it’s rare for two people to swap their properties with each other in a simultaneous direct exchange.
Instead, the majority of exchanges are delayed three-party exchanges done with a qualified intermediary—ordinarily a professional who specializes in Section 1031 exchanges.
In the delayed exchange, the tax code binds you and the intermediary to strict time limits for the transactions.
To make this work, your first step is to engage a Section 1031 intermediary. Second, you need to buy a replacement property of equal or greater value than the property you sell.
Exchange
You may have noted that I left out the word “exchange” when introducing Section 1031. I did that on purpose because to exchange means to trade. In the Section 1031 exchanges, I’m familiar with, it’s never a swap of properties. Instead, it’s a sale and purchase using the Section 1031 rules to defer the taxes.
The Section 1031 exchange rules are complex and include strict deadlines for identifying and acquiring the property involved. To do this right, you need a qualified intermediary, which can be a bank, a lawyer, or a Section 1031 company.
In the past, Section 1031 allowed both personal property and real property exchanges. The Tax Cuts and Jobs Act eliminated personal property exchanges, such as trading in your vehicle for a replacement. But real property exchanges remain. They are true tax-saving machines. And the new IRS regs make it clear that a Section 1031 transaction does not get in the way of cost segregation—a method used to speed up depreciation on real property.
Takeaways
Here are six things to remember from this Blog:
- Because of the TCJA, you now may use Section 1031 tax-deferred exchanges for real property only. (You have to love the “tax-deferred” part—and remember, if you keep doing this until you die, your tax-deferred part could become tax-free.)
- Real property for Section 1031 purposes includes all property defined as real property by the state or local law where the property is located.
- Real property for Section 1031 purposes includes land, buildings, inherently permanent structures, and structural components.
- You can qualify for a Section 1031 exchange so long as no more than 15 percent of the replacement property’s fair market value consists of personal property.
- You can use cost segregation on real property to speed up your deductions without damaging your Section 1031 tax advantages.
- The word “exchange” is a misnomer because in a Section 1031 exchange you don’t generally swap properties with someone else. Instead, you generally use an intermediary to help you sell your existing property and buy the replacement property.
If you would like to discuss the possible use of a Section 1031 transaction to upgrade your rental or business property portfolio, please call me on my direct line at 509-543-7600 or send a request HERE.
June 2021
This blog does not provide legal, financial, accounting, or tax advice. This blog provides practical information on the subject matter. The content on this blog is “as is” and carries no warranties. TaxMedics does not warrant or guarantee the accuracy, reliability, and completeness of the content on this blog. Please contact us directly to discuss how this information may be used based on your actual facts and circumstances.