Fundamentals of the 1031 Exchange

When real estate is sold it is generaly a taxable event. The proceeds of that event must be reported for federal income in the year the sale occurs. However, there are a few cases where this general rule does not apply. The purpose of this article will be to explain one of these exceptions: the 1031 exchange.

Outline of a 1031 Exchange

Under federal tax law when real estate is exchanged under a particular set of circumstances, taxes may be deferred. This deferral of taxes is permitted when the proceeds from the sale of real estate investments is used to purchase a property that is a like kind property as understood by federal tax law. Basically you put up for sale a real estate investment, transfer the proceeds to a qualified intermediary, then reinvest the proceeds into another real estate investment. Should this be performed the right way, with the right professional assistance, taxes are deferred as long as the capital remains invested.

When considering selling your property you have several options

1. Sell the property and pay the capital gains.
2. Sell your investment property, pay the capital gains tax, and then invest the the left over funds for you next real estate purchase.
3. Last, you can sell the real estate investment, work with a qualified intermediary, purchase a like kind property, and pay no capital gains.

Obviously, most of us will choose the third option if we understood what was involved. It is highly recommended that each investor discusses their specific situation and needs with an experianced professional. It is simple but you do need to follow the guildlines very carefully or you might be subject to capital gains taxes. Follow the rules and you will be able to continue to realize the benefits of your investment without paying capital gains when you move your investment. This is of course very beneficial for people who have had real estate appreciate considerably and would like to invest in other types of property.

Before you do 1031 exchanges you need to grasp the following:

1. Like Kind Properties
2. The Qualified Intermediary
3. Tenancy in Common

We have looked over the specifics and more. Of course you will need to consult a professional in order to ensure you really are able to meet the terms of Section 1031 of the federal tax code.

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