A 1031 exchange is known as a like-kind exchange and can be an effective tool for those who have investment real estate. When selling investment real estate, most people face a significant tax burden. A like-kind exchange can significantly reduce or even eliminate this burden, by deferring a capital gains tax which might otherwise arise at the time of the sale of investment property.
The 1031 Exchange Rule
Property can only qualify for a like kind exchange if the taxpayer follows specific rules as laid out by the US tax code. Investment properties can only be exchanged for properties that are another investment. For example, you cannot trade a business property for a residential property unless the residential property is going to generate income. One or more rental condominiums can, though, be exchanged for a multi-family home. The second (and perhaps most often violated) rule for a 1031 exchange is how the proceeds of the sale are handled. For example, you cannot take the proceeds from one sale and buy or pay off another property you own. This type of transaction will result in all proceeds being taxable. And very important, neither the taxpayer nor his or her representatives (attorneys and accountants included) can handle the proceeds during the exchange. The funds must be handled by a qualified intermediary.
1031 Exchange Deadlines
The IRS also places guidelines on how much time an investor has to take advantage of a like-kind exchange.
• 45 days: When selling a property, the seller has 45 days after the sale is complete to identify a new property to exchange.
• 180 days: The final purchase and closing must be completed on the new property for the 1031 exchange to be valid.
Another important note is that weekends and holidays are counted under Massachusetts law in these counts. This is especially important during November and December given the number of banking holidays that occur during these months.
Important facts to keep in mind
There are three guidelines that must be met in order for a like-kind exchange to be successful. They are:
• The property has to be of the same nature – In other words, a seller cannot sell a strip mall and buy a vacation home.
• Property value – the purchased property must be worth as much or more than the sold property. Otherwise, capital gains taxes may be due on the deficiency.
• Ownership – the ownership of the purchased property must be the same as the sold property. For example, you cannot sell a property in your business name and buy a property in your personal name.
When you are considering selling property and taking advantage of Massachusetts 1031 exchanges, it is a smart decision to hire an experienced real estate attorney to help you. We can help make sure your 1031 transaction meets all the requirements before you make a costly mistake.