Three Basic Things You Should Know About IRS Section 1031 Exchange Requirements
Internal Revenue Service Code Section 1031 is specifically related to the deferment of capital gains tax on property dispositions. When this is done, it can free up more of your money that you can use to purchase more properties. This alone makes it a valuable tool in building wealth through real estate. However, there are rules associated with this type of property exchange. The following are a few of the basic rules associated with this.
The transaction must be structured as an exchange
In other words, it cannot be a sale or a purchase. To make sure it is done properly, the exchange is accomplished by using a qualified intermediary to facilitate the sale of the property and the acquisition of a new one. It is the intermediary that holds the funds from the sale of the property.
The transaction must be of like-kind properties
The two properties involved in the exchange must be considered of like kind. The definition for this is wide-ranging, but this includes rental property in a residential housing tract, an apartment complex, commercial buildings, or office buildings. But regardless of the specific property, it must be considered real property, either buildings that are attached to the land or the land itself. But regardless of the type of property, it must always be an investment property. Properties that are excluded include personal residences, vacation properties, and properties that are new to the market, such as those sold by a builder.
To defer all tax, the replacement property must be equal or greater in value
In addition to the new property value, both the equity and debt must be of equal or greater value than the property that you are giving up in the exchange. All of these criteria must be met to receive a full tax deferment. If not, there may be a partial tax deferment, but you will still have a tax bill.
The idea behind IRS section 1031 is to defer taxes on capital gains. This can mean freeing up additional investment income to purchase more property. There are many rules associated with this IRS code; the rules listed above are among the most basic. However, interpretations of the rules can change, so to get the latest information and a robust understanding of what you can and cannot do, seek out the advice of a tax specialist. A professional can tell you more about 1031 exchange rules.