WHAT IS A TAX FREE EXCHANGE?
Partially born in the summer of 1990, Section 1031 of the U.S. Internal Revenue Code, allows investors to trade one property for another without paying federal income taxes on the transaction — provided certain qualifications are met. This makes it possible for investors to sell and buy property of “like-kind” while deferring tax consequences.
In essence, a 1031 tax exchange allows an investor to reinvest 100% of the equity from one sale of a property – into the purchase of a replacement property – without recognizing any gain. This type of property sale and reinvestment can either be done through a simultaneous or delayed 1031 tax exchange. Normally, a 1031 tax exchange is handled as a three-party delayed exchange, or “Starker Exchange”, in which an “intermediary” ensures a reciprocal transfer of the properties and provides a “safe harbor” against the actual receipt of exchange funds.
Note: You should always consult a tax professional when you are doing anything related to taxes and/or real estate.
WHAT IS THE ADVANTAGE OF A 1031 TAX FEE EXCHANGE TO ME?
The clear Advantage to the investor for using a Tax Free exchange is the deferred capital gains tax. This means that the taxpayer has more cash on hand to reinvest – or “trade-up” – into another, more valuable replacement property. Keep in mind that all states handle their tax differently. Some states conform to Federal income tax laws while other states do not. Contact Lawyers Advantage Title Group for the specifics concerning your state.
WHAT IF I PURCHASE THE REPLACEMENT PIECE FIRST?
Usually, this will still qualify for a 1031 Tax Free Exchange, although considered a “reverse exchange”. As long as the requirements of Internal Revenue Code Section 1031 are satisfied, especially with regards to timing and money flow, 1031 Exchanges can be either a forward exchange (sell then buy) or a reverse exchange (buy then sell).