Financial Resource

Article by David East

If an investor wants to defer state and federal capital gains taxes, then they will often take advantage of The Internal Revenue Code 1031 (IRC 1031) property exchange, which allows them to exchange one property for another without paying those taxes. Of course, the properties must qualify as “like-kind” and the number of days allowed to complete the transaction must be met before the exchange will be approved by the Internal Revenue Service.

A 1031 like kind exchange is not really an avoidance of tax; it is more of a rollover of equity of like properties so that you can continue to build wealth through investing in real estate. Ever since 1921 there has been an exception in the Capital Gains tax code that states the tax can be deferred if the investment property is not sold but exchanged instead.

The idea behind the IRC 1031 is that a taxpayer should be able to get rid of income or investment property and obtain a replacement income or investment property without having to incur what could be a rather large capital gains tax amount. The 1031 exchange rules have changed very little since that time but there are some basics and tips that are very helpful to know.

This tax deferred 1031 exchange is much more than just selling an investment property, such as a rental house, and then turning around and buying another rental property. There are some very creative possibilities with this code. Perhaps you should consider purchasing a property in the area where your child is going to attend college, holding it as a rental, and then completing a 1031 exchange after they have graduated. Many investors are leery of selling a property after making a substantial gain in the market, so opting for a 1031 property exchange would allow them to exchange a residential property for office or business rentals.

Often times a real estate investor reaches a point where they want to be able to slow down, retire and possibly cash out. Whether the investor owns land, warehouses, rental houses, apartment complexes or business offices, utilizing the IRC 1031 property exchange may enable them to find a replacement property that is a better located residential property in an inviting setting, perhaps a mountain resort or beach condominium, where they may choose to live out their life. In order to qualify for the tax deferred status they have to be held for investment and in order to comply with this the investor will usually put the property on some type of rental program and then later use what is called conversion. After a few years of completing the original 1031 real estate exchange, they simply move into the previously rented investment property with no tax obligation due.

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