A 1031 exchange can be a very valuable tool for real estate investors who are looking to increase their wealth without investing more money out of their pocket. This is because a 1031 exchange allows investors to use the proceeds from the sale of one property to purchase another property rather than using a portion of these funds to pay capital gain taxes. However, several rules must be followed in order to complete a 1031 exchange. You can learn more about four of these rules below.
#1: A 1031 Exchange Can Only Be Used When Buying Business Or Investment Properties
The IRS tax code that applies to 1031 exchanges does not apply to the purchase of owner-occupied properties. Consequently, you will not be able to defer capital gain taxes when selling an investment property to purchase a new primary residence or vacation home. Instead, you will only be able to execute a 1031 exchange when purchasing a new business or investment property.
#2: The Property You Are Purchasing Must Be Equal To Or Greater In Value Than The Property You Are Selling
When executing a 1031 exchange, you must purchase a property that is either equal to or great in value than the property you are selling. Consequently, you may still be required to find additional financing for your new property even if you use the full proceeds from your sale to fund your purchase.
#3: You Must Use The Proceeds From The Sale Of Your Property To Buy A Qualifying Property Within The Required Time Limit
There are time limits associated with your ability to defer capital gain taxes through the use of a 1031 exchange. If you are unable to close on the purchase of your new property within the required time limit, you will be responsible for paying any capital gain taxes due on the sale of your original property even if you ultimately end up purchasing a property. When possible, it is ideal to close on both the sale of your original property and the purchase of your new property on the same day.
#4: Capital Gain Taxes Are Only Deferred As The Result Of A 1031 Exchange
Executing a 1031 exchange does not eliminate your tax obligation. Instead, this process simply allows you to defer the capital gain taxes that are due on the sale of your original investment property. If you choose to sell your newly acquired property in the future, you will still be required to pay both the past and current capital gain taxes. However, you may be able to continually defer these taxes by choosing to execute a new 1031 exchange each time you sell an investment property.
To learn more about 1031 exchange rules, contact a professional tax service in your area.