Under Internal Revenue Code Section 1031, real estate investors may defer recognizing capital gains on their income tax returns. By exchanging real property for another that is similar in type, or “like-kind,” you may defer capital gains taxes, and in some cases, defer them indefinitely.
According to the IRS website, the law considers two properties as like-kind when they have a similar character or nature. The IRS may accept a transaction as a like-kind exchange even when two properties reflect different values or grades.
How may I plan for a like-kind property exchange?
As reported by BusinessInsider.com, investors may find a new like-kind property after selling their previously owned property. After a sale, you may forgo paying capital gains taxes by depositing the sale transaction’s proceeds with a qualified intermediary.
The IRS provides real estate owners 45 days from the date of a property sale to identify a new like-kind property suitable for purchase. The new transaction’s closing, however, must take place within 180 days of selling the previously owned property.
If you sell an improved apartment building, you may deposit the proceeds with an intermediary for 45 days. During that time, you may find an unimproved residential building of the same nature. By purchasing it within 180 days of your sale, the transaction may qualify as a 1031 exchange.
How may I prepare to sell my property for a 1031 exchange?
Before listing a property, a professional appraisal provides a fair market value that could guide your plans. A new like-kind exchange must have an equal or greater value compared to your existing property.
The IRS allows investors to buy an unlimited number of like-kind properties. Their combined market value, however, may not exceed 200% of an existing property’s sale price. Accordingly, investors may use their 1031 exchanges to build wealth through real estate.