Whether you have one property or numerous properties to transfer using a 1031 exchange, Citadel Realty can assist you with your real estate goals. Below is information about what a 1031 exchange is and how it works.
A 1031 exchange, otherwise known as a tax deferred exchange, is a simple strategy and method for selling one property, that’s qualified, and then proceeding with an acquisition of another property, also qualified, within a specific time frame. The logistics and process of selling a property and then buying another property are practically identical to any standardized sale and buying situation except for the fact that the entire transaction is treated as an exchange and not just a simple sale. This allows the taxpayer(s) to qualify for a deferred gain treatment.
Any real estate property owner or investor of real estate should consider an exchange when he or she expects to acquire a replacement “like kind” property subsequent to the sale of an existing investment property. The main reason for a 1031 is that the IRS depreciates capital real estate investments at a 3% per year rate as long as you hold the investment, until it is fully depreciated. When you sell the capital asset, the IRS wants to tax you on the depreciated portion as an income tax, and that would be at the marginal tax rate. For example, if you hold an investment for 15 years, the IRS depreciates it 45%. It then wants you to pay the taxes on that 45% depreciation. If combined state and federal taxes are 35% at the marginal rate, that’s about 15% of the cost of the property (one third of 45%). If your property is fully depreciated, it becomes the whole 35% marginal tax rate. There are two major rules to follow:
- The total purchase price of the replacement “like kind” property must be equal to or greater than the total net sales price of the relinquished, real estate, property.
- All the equity received from the sale of the relinquished real estate property must be used to acquire the replacement “like kind” property.
There are 2 timelines that are crucial to abide by in the IRS 1031 exchange rules. There is the identification period during which the party selling a property must identify other replacement properties that he/she wishes to buy. The period is scheduled as exactly 45 days from the day of selling the relinquished property. This 45-day timeline must be followed under any and all circumstances and is not extendable in any way, even if the 45th day falls on a Saturday, Sunday or legal US holiday.
Then there is the exchange period. This is when the person who has sold the relinquished property must receive the replacement property. This time period ends at exactly 180 days after the date on which the person transfers the property relinquished or the due date for the person’s tax return for that taxable year in which the transfer of the relinquished property has occurred, whichever situation is earlier.
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