Section 1031 Exchange, of the U.S Internal Revenue Code, allows you to postpone the payment of capital gains if you sell a business or investment property and buy a similar (“like-kind”) of property with the funds.

The 1031 exchange will allow you to avoid paying capital gains tax if you are planning to sell a property that might result in a huge profit. This section of the Internal Revenue Code will allow you to defer the payment of taxes if you purchase another property to substitute the one you had.

What Can Qualify For A 1031 Exchange?


Any type of real property can be exchanged provided that both of them are business or investment property. The properties must have a productive use in a trade or business or for investment.

The relinquished and replacement property should be like-kind. This term refers to the nature or character of the property, not the specific type of property. Almost all kinds of property will qualify for a like-kind, except property being used personally or held for sale.

Therefore, you cannot qualify for a 1031 exchange if you are planning to upgrade your current home or vacation home. Similarly, bonds, certificates of trust, debt instruments, inventory, partnership interests, stocks all do not qualify for a 1031 exchange.

How Should I Use The 1031 Exchange?


You can use the 1031 Exchange to defer capital gains tax, but you will need to make sure that the property you are selling is a business or investment property.

Moreover, the recommended way of filing for a 1031 Exchange is through a qualified tax professional. However, here are some basic steps you will need to follow to file for a 1031 Exchange.

Having a business or investment property is a given and you must remember that your residence or second home does not qualify for a 1031 exchange. Secondly, the property you are selling and the property you are going to buy should be “like-kind.”

They do not need to be of the same quality or grade, but they should have a similar nature. Remember that you cannot apply for a 1031 Exchange for a property outside the U.S.

The next thing you will need to do is to find a qualified intermediary. This intermediary will work as an exchange facilitator so you do not receive funds earlier and to make sure that you do not pay any income tax until the exchange occurs.

The price of the property you are buying should be equal to or more than the relinquished property. In case the property you are buying is of lower value, you will not qualify for a 1031 Exchange.

Once you have sold your property you will need to find the next property within 180 days. You will also need to inform your intermediary about the possible purchase. Since the 1031 Exchange’s goal is to defer tax payment because you did not receive funds from the sale of your property. You should avoid transferring the amount to your name because then you will be eligible for capital gains tax.

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