The 1031 Exchange. If you live in NYC and have ever owned an investment property, you are quite likely familiar with that term. The 1031 Exchange has long been considered one of the most powerful wealth building tools in the real estate world. 

But for those of us who haven’t yet delved into investing in real estate beyond a personal residence, Section 1031 of the Internal Revenue Code may be a completely foreign concept. So let’s break this code, which allows for a taxpayer to sell income, investment or business property and replace it with a like-kind property, down, shall we?

What is a 1031 Exchange?
A 1031 exchange is a tax-deferred exchange involving the sale of one qualified property for the acquisition of another qualified property within a specified time frame. What’s a qualified property, you ask? Don’t worry, we will cover that in the next sections.

The second important thing to know about 1031 exchanges is that all of the proceeds from the originating sale must go towards the acquisition property. Any cash proceeds remaining are eligible for taxation.  

The third main aspect involves the time frame allowed in a 1031 exchange. There are two timelines during a 1031 exchange-- the identification period, which lasts 45 days from the sale date of the originating property, and the actual exchange period, which is 180 days either from the originating property sale date or from the tax return due date of the year in which the property was relinquished. These dates must be strictly adhered to, regardless of the day of the week they fall on or whether they fall on a holiday.

Who qualifies for it and what additional requirements are there?
The biggest qualifier when it comes to a 1031 exchange is that the “qualified property” being exchanged and the one it is being exchanged for must be held for strictly productive purposes like a business or as an investment. 1031 exchanges are not eligible for residential properties, vacation homes included. 

Another important factor is the idea of “like-kind” properties. Before changes were made to the code in 1984, “like-kind” literally meant that the properties you were swapping had to be essentially the same. For instance, an apartment complex for an apartment complex, a hotel for a hotel. You get the gist. Now, the rules around what can be exchanged for what have loosened considerably. “Like-kind” is only another way of saying that they must both be investment or business properties. Want to exchange a farm for a shopping complex? An office building for a condo? These would all qualify under the new rules. 

What are the benefits of using it?
The primary, and most obvious, benefit to undergoing a 1031 exchange, rather than a simple sale, is that it falls under rules that allow for the deferral of capital gain taxes. Simply put, sales are taxable by the IRS and 1031 exchanges are not, leaving you with more cash flow for future investments. 

Many investors use the 1031 exchange as a smart way to invest in multiple properties over a number of years, saving them huge sums in taxes that they would accumulate if they simply sold and bought properties outright. 

While the process can be arduous and complicated-- this is not a DIY undertaking for new investors and a qualified intermediary should always be consulted-- in the end, it is a great strategy for those who are looking to delve into long-term real estate investment.

For more info, check out the 1031 Resource Center or reach out to a Bracha New York agent today!

Image courtesy of DNAinfo.com.

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