1031 Exchange Rules and Requirements
The Internal Revenue Code of the United States declares, under Section 1031 Exchange, that the swap of specific types of real estate property may defer due taxes applied on regular capital gains. If you represent a business that holds as asset one real estate property which, if sold for cash, would cause profit loss, this 1031 tax-deferred Exchange should definitely be on your option list.
The most practical usage of the 1031 Exchange is to defer capital gain or loss upon a real estate sale, if this approach suits your current situation. The simplest, most straight forward guideline of the 1031 Exchange is that the real estate properties destined to personal usage do not fall under its incidence. This Section of the Internal Revenue Code mostly applies to businesses, as the properties to be exchanged must be owned (held) for specific productive, business purposes by a company. Initially, the 1031 Exchange (the ownership exchange) needed to take place simultaneously. In 1979, the rules for a delayed exchange originated in a court of law. You do no longer need to exchange real estate property in the same time but, with the help of a qualified intermediate, you can now also sell your property before finding a replacement, providing that the middle man is the one to hold your cash until the new property is acquired. This is valid providing that you identify the exchange property in 45 days and complete the transaction in maximum 180 days.
The biggest advantage of the 1031 Exchange may be the Deferral of Taxes. This approach helps you sell your investment property and reinvest in a different real estate asset, without suffering through market depreciation. This priceless, exceptional tax-deferral exception allowed by the IRS, should do wonders helping a realtor, who is building a real estate portfolio or who is struggling in a rough market, reinvest and survive without owing money to the state.
Increased cash flow should also be one main advantage of the 1031 Exchange. Exchanging properties, without passing through all the associated taxes you would pay if you sold for cash, can indeed be very lucrative.
Maximizing the return of a real estate investment should also not be something treated lightly and the 1031 Exchange facilitates exactly that. Imagine exchanging real estate properties without having to pay taxes until the market is favorable and you can finally sell for cash and not lose a cent, if this is your final purpose.
One main disadvantage of the 1031 Exchange represent the multitude of rules and regulations one must follow for a successful application. The IRS does indeed facilitate this tax-deferring approach in order to encourage small and medium-sized businesses not to file for bankruptcy. They will however NOT make it easy on you.
The future increase of owed taxes is not something to be treated lightly. If you manage to steadily increase the value of your real estate portfolio through the 1031 Exchange, it is safe to say that, when finally deciding to sell for cash, the taxes will be comparable to your more valuable property/properties. This aspect also implies an increased future cost of transactions. Do not forget that this section is tax-deferred and not tax-free!
According to Investopedia.com
“boot” is cash or other property added to an exchange or other transaction in order to make the value of the traded goods equal.
You must consider mortgage loans on the property you hand over as well as any debt on the replacement property, as any boot received is taxable (to the extent of gain realized on the exchange). If you would like the entire exchange to be tax free boot should be avoided. In case your liability goes down, it will also be treated as income just like cash.
Anyone with a basic comprehension of tax-deferred, real estate property exchanges does surely appreciate and use this method in order to defer owed taxes indefinitely and guide their company through tough times, without having to pay penalty or interest.