1031 Exchange Lawyers

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Exchanging Real Property

When exchanging real property, most taxpayers will end up reporting a gain or a loss on their income tax. This tax, called a capital gain tax, can exceed 20-30% of your monetary or property gain (the purchase price minus the selling price) leaving you with severely depleted buying power when you go on to make an exchange for a different building. However, a legitimate 1031 Exchange can help you evade the issue of taxable property gain entirely.

What Is a 1031 Exchange?

A 1031 Exchange, also known as a like-kind exchange or a tax-deferred exchange, is a real estate law that allows taxpayers to file for the non-recognition of taxable gains or losses when there is an exchange of "like-kind" property. Essentially, this allows a taxpayer who owns real property to trade or exchange that property for another, similar property without having to pay taxes on the sale or purchase of either property. The idea behind this kind of exchange is that the taxpayer is exchanging one property for another and, as a result, will not receive any monetary gain from the trade. With all of the value or money locked into the real estate, there is nothing to claim for income tax.

How Does a 1031 Exchange Work?

1031 Exchanges are governed by a strict set of rules which determine whether or not property qualifies, how the sale or exchange should take place, and what the parameters for the exchange are. These are laid out as three basic rules:

  1. The properties involved in the exchange must be both "like-kind" and be held for a productive purpose in trade or business, as with an investment.
  2. You may not deal directly with the money involved in the exchange. A qualified intermediary must be hired to handle all proceeds from the sale.
  3. The property intended to replace the current property must be subject to either an equal or greater level of debt than the current property. This means that you cannot exchange a greater-valued property for a lesser-valued property, or else you will be taxed on the difference.

Failing to comply with any of these rules means that you will fail to qualify for a 1031 Exchange, and thus be required to pay income tax on the sale and purchase of your properties. These kinds of taxes are also referred to as "Boot."

How Long Do I Have to File for a 1031 Exchange?

The 1031 Exchange is divided into two basic periods: the Identification Period and the Exchange Period. Timelines for both of these periods are strict, and it is vital to adhere to all deadlines, as they cannot be extended for any reason, even if they fall on a weekend or major holiday. The Identification Period is the period during which you must identify potential replacement properties that you wish to buy and that will be involved in the exchange for your current property. This period begins immediately upon selling the original property and only lasts for 45 days. The Exchange Period lasts slightly longer, again starting on either the date recorded on the deed or the date on which possession of your sold property is transferred to the buyer; whichever is earlier. This period only lasts for 180 days, but may also end on the day that your tax return is due, again, whichever comes first.

What Is the Benefit to Making a 1031 Exchange?

The primary benefit to a 1031 Exchange is that the taxpayer does not need to pay taxes on any money gained from the sale of their initial property, because all of that money will be invested into the new property and thus never becomes legally free for taxation. If you were to sell your property yourself, hold on to the money, and then use it to purchase a new piece of property, you would be subject to standard income tax on your purchase and sale.

Do I Need an Attorney to Help Me Complete a 1031 Exchange?

If you are familiar with 1031 Exchange or "like-kind" laws, you may proceed on your own. However, tax laws are constantly fluctuating, and if you are at all uncertain about whether you qualify for a 1031 Exchange, you should get in touch with a real estate lawyer who can help you to better understand your options. An attorney can also assist you by representing you before the IRS if you are subject to a collection process.

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Last Modified: 06-23-2014 03:03 PM PDT

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