| What is a section 1031 Tax Deferred Exchange?
What is a section 1031 Tax Deferred Exchange?
Generally speaking, whenever a taxpayer sells an investment property, the gain on this sale is subject to capital gains tax. The resulting gain on the sale of the property could be due to the extent of taking depreciation deductions for tax purposes or by the property appreciating in value during its ownership.
A section 1031 tax deferred exchange, named for the Internal Revenue Code Section it refers to (also known as a Starker Exchange, Tax Free Exchange, or Like-Kind exchange), allows an exception to the capital gains tax.
What this means, is that when a taxpayer sells their appreciable investment property, replace's it with another qualified investment property, and complete an exchange as specified by the code section 1031, the taxpayer would be able to defer the payment of the capital gains tax normally required on these sales.
The impact of a 1031 Exchange is that it provides greater proceeds for your next investment, due to the tax deferment of the capital gains tax. A 1031 Exchange is not a tax loophole, in fact it was written and designed by Congress, to permit anyone who meets all the requirements to sell their property and defer paying capital taxes on the gain.
What are the requirements of section 1031 Tax Deferred Exchange?
The IRS code section 1031 specifically states that in general, "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment".
However as always there are exceptions to the code section. These are as that the above code section "shall not apply to any exchange of Stock in trade or other property held primarily for sale, or Interests in a partnership".
This Code Section has stringent requirements in the that the property be identified and that exchange be completed not more than 180 days after transfer of exchanged property. For purposes of this subsection, any property received by the taxpayer shall be treated as property which is not like-kind property if,
(A) such property is not identified as property to be received in the exchange on or before the day which is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange,
or (B) such property is received after the earlier of (i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or
(ii) the due date (determined with regard to extension) for the transferor's returnof the tax imposed by this chapter for the taxable year in which the transfer of the relinquished property occurs . . ."
What are the advantages of a 1031 Tax Deferred Exchange?
Some of the more important advantages of the tax deferred exchanges are as follows:
1. The Exchanger will have more buying power due to the deferment of capital gains taxes. This will create additional cashflow that will enable the exchanger to reinvest more of his funds and secure better financing terms.
2. There are no limits to how many times Investors can do exchanges, so in effect multiple exchanges can be done that would create a pyramiding effect. The deferred tax liability is eventually forgiven upon the death of the investor as the heirs get a stepped-up basis on the inherited property. Hence, with careful tax planning it would appear that Investors could conceivably avoid paying any capital gains taxes!
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