A tax-deferred exchange allows taxpayers to sell income property and replace it with a “like-kind” property. If you are selling an investment property with the intention to reinvest in another investment property, you might be able to avoid capital gains taxes on the sale.
Section 1031 of the Internal Revenue Code allows such exchanges, which permit the postponement of capital gains tax payments when another property is purchased within a specified time period. Income property investors can use it to defer taxes when they sell an apartment building, for example, and buy land to build a new duplex on.
This has been called the most powerful wealth building tool available to taxpayers. For landlords, it’s an important tool to increase the size of your real estate holdings. It’s also a good way to sell non-income-producing property, like land, in exchange for income-producing property, like a rental house.
In theory, an investor could continue deferring capital gains on investment property forever, avoiding them completely. But as with any tax rule, following the 1031 Exchange mandates to the letter is a must.
What property qualifies for 1031 Exchange?
- Real estate property held for investment
- Purchase and sale properties located in the United States only
- Purchase property priced equally to or higher than the sale property
- Purchase property that closes within 180 days of the sale property’s closing
What properties do not qualify for 1031 Exchange?
- Property purchased to fix up and “flip”
- Vacation or second homes not held as rental properties may not qualify—check with your tax advisor
- Personal residences
Important Information on 1031 Exchanges:
- There are certain disadvantages of 1031 Exchanges, regarding losses and depreciation. Check with your tax advisor.
- Every taxpayer’s situation is different. Check with your tax professional for more information on whether the 1031 can benefit you.
- The limitations and requirement of 1031 Exchanges are complicated and should be undertaken with the guidance of an expert.