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The Skinny on a 1031 Exchange

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1031 exchange

If you’ve been investing in rental property for any length of time, you’ve probably heard about something called a 1031 exchange.  Although 1031 exchanges can only be used in specific situations, if and when you do need to use it, you can save thousands or even tens of thousands of dollars in tax expense.  The purpose of this post is to provide an overview of this helpful IRS rule – section 1031 of the IRS tax code.

First off, it is important to note that a 1031 exchange can only be used for transactions involving investment properties, not your personal home.  It is used when you sell one property and quickly purchase another one that has similar characteristics.  Thus, instead of selling property A and then buying property B, you simply exchange property A for property B.  Because the tax code treats this as an exchange relative to property A, and not a sale, there is no capital gains tax, which at the time of this writing is 15% of profit assuming you’ve held the property for at least 1 year (if less than 1 year, then your normal tax rate would apply).  The bottom line is that this tax code allows investors to get rid of an old property and buy a new one without any tax consequences.

There are actually 3 different types of 1031 exchanges: delayed exchange, simultaneous exchange and build-to-suit exchange.  The first 2 are self-explanatory.  The third type is when some of the profits from the sale of the old property are used to enhance the new property. No matter what the type, there are several common requirements.  For example, the properties must be similar to each other, preferably both within the US, and the new property should be within the taxpayer’s specific line of work or investment portfolio.

As you can see, if you are a landlord or investor, 1031 exchanges can save you boatloads of money, so it’s definitely worth looking into.  That said, aside from the requirements I mentioned above, there are other rules and time requirements as well, so if you plan to execute a 1031 exchange please visit the IRS page on real estate tax tips and get up to speed on the tax code, and/or consult with an attorney familiar with property law, or accountant for advice.

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