-
A "tax free" exchange is not actually tax-free, but instead tax-deferred. A property exchange under IRS Code Section 1031 is not a way to avoid taxation, but rathery a way to postpone those taxes from being assessed immediately on profits from investment real estate transactions. A 1031 exchange is a two-part process in which a property is sold. The seller of that property then puts the proceeds into another property within the allowable time period.
To be 100 percent tax-deferred, the property purchased by the seller of the first property must be of equal or greater value to the property sold, and all of the net proceeds from the sale must be spent on the new purchase. - There are both "simultaneous" and "delayed" 1031 exchanges. However, almost all exchanges are "delayed," since a simultaneous exchange requires the closing of both the sale and purchase to occur on the same day. The delayed option allows the seller/purchaser to deal with delays on one or the other property and avoiding a potentially failed 1031 exchange and no tax benefits.
-
Three characteristics must be present to successfully complete a delayed 1031 exchange.
First, the purchase price of the property that is replacing that sold must be equal to or greater than the net sales price of the property that's been sold. Second, all equity from the sale of the first property must be used to buy the new property or properties. Third, the property being bought must qualify for exchange by being "like kind." -
The easiest way to figure out what is "like kind" property is to know what it isn't. Basically, any property that is not a personal residence or a second home qualifies.
This means that any property held for use in a trade or business, such as rental or income property, or property that is meant for investment purposes is a "like kind" property. Further, the properties sold and purchased don't have to be exactly the same type. So, a rental property can be exchanged even for unimproved land, so long as the land being purchased is of equal or greater value to that being sold. - An exchanger has a maximum of 180 days from the time he completes the sale of one property (or the due date of that year's tax return, should that date be earlier), to purchase the replacement property. Sometime within the first 45 days of that 180-day period, the new property or properties must be identified.
-
Correctly qualifying the property into which the proceeds from a sale will be transferred is a critical step. This is a primarily financial qualification.
What is known as the Three Property Rule allows that an investor can identify up to three properties, one or more of which can be purchased within a following 180-day window. These properties total value may not exceed 200 percent of the value of the property that was sold. There is one exception to the 200 percent rule, and it happens when the identified property/properties do not exceed the value of the property sold. If the property/properties are valued at 95 percent or more of the property sold, the property being purchased still qualifies under the 1031 exchange program.
