Tax-Deferred Exchange Rules

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Tax-deferred exchanges describe transactions in which one asset is relinquished in exchange for another asset of like kind. The exchange itself generates no tax consequence and is often considered tax-free. This is tax-free until a later point when the asset is liquidated into its cash equivalent. There are three areas of tax-deferred exchanges: 1031 exchanges, 1035 exchanges and retirement plan rollovers.

1031 Exchange

A 1031 exchange is a tax-deferred like-kind exchange that usually involves real estate but can also be done with boats, collectibles and livestock. The exchange must occur within 180 days from the date of relinquishing the first asset with the new potential asset being identified no later than 45 days from the relinquishing. Like-kind does not need to be the same quality, just the same nature and character. So a personal home cannot be exchanged for a rental property nor can livestock of different sexes be exchanged. But a rental home worth much less than another rental home can be exchanged with losses not being acknowledged.

1035 Exchange

A 1035 exchange is an exchange of assets held in an annuity, life insurance policy or endowment into a new policy or endowment without generating a tax consequence. Gains and losses are not recognized in these exchanges. Life insurance must exchange into a new life insurance policy and not an annuity or endowment. The same is true for annuities and endowments: They must transfer into the same type of account. Endowments must further transfer into a new endowment that has a maturity date that is the same as or sooner than the endowment being replaced. Exchanges must go from company to company and not pass through owners. IRS notice must be accompanied with the 1035 exchange usually as part of the company paperwork and forms.

Rollovers and Transfers

Retirement plans already grow tax-deferred. If a person leaves a company, he has the option to roll the money into a self-directed rollover IRA. With the paperwork filed for rollover distribution with the previous employer, a distribution of the assets is made by physical check payable to the trustee. This check must be placed in the new IRA within 60 days to not be taxed. Rollovers can be done once per 12 months from accounts where a distribution is sent directly to the owner. Transfers move IRA assets from one IRA into a new IRA with the transaction occurring between IRA trustees with no physical check issued. It does not liquidate the assets that can be moved in-kind. There is no limit to how many transfers can be done per year, but the account must be owned by the same person and placed into the same type of IRA. The exception is traditional IRAs converting into Roth IRAs but these are taxable transfers moving the money from a tax-deferred vehicle into a tax-free one.

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