Surprising as it may seem, it is possible to sell a real estate property and avoid paying capital gains tax. But how? There are multiple ways to avoid paying capital gains tax, but the most popular one is the 1031 exchange. Much has been written over the years to explain the working mechanism of the tax deferred exchange, yet it seems that the matter is still unclear. Simply put, a 1031 exchange allows businesspeople to be fully tax-deferred when exchanging properties. Oaky, maybe this is not a very clear explanation. If you want to find out more about tax-deferred exchanges, keep on reading.
What is tax-deferred exchange?
Under the section 1031 of the US Internal Revenue Code, owners of commercial real estate property can use their possessions in a trade or business swap tax-free. If you do a tax-deferred exchange, you basically do not have to pay capital gains tax on profits. This type of transaction is also known under the name of like-kind exchange and Starker. There is no limit to the number of times that you can do a tax-deferred exchange. Special attention should be paid to the fact that tax-deferred exchanges are not for personal use.
Requirements for tax deferred exchange
If you want to do a 1031 tax-deferred exchange, you should know that there are certain rules you must follow. This is how to complete a successful transaction:
· Respect the timelines
The Internal Revenue Code rules are pretty specific timelines when it comes to like-kind exchanges. The investor, meaning you, has 45 to 180 days to finalize the transaction. From the moment that you sell your property, you have exactly 45 days to find a like-kind one. Once you have identified the perfect replacement, you have 180 days to sell your estate and buy a new one.
· The property must be like-kind
The timelines are important, but so is finding a like-kind property. The term ”like-kind” can be misleading. It refers to real estate property of the same kind. The assets have to be of the same time, but it is not necessary for them to be of the same quality or grade. For example, you can swap two residential estates. What you cannot do is exchange a residential estate for farming equipment.
· Designate the replacement property and close the deal
You have sold your asset. What do you do now? The thing you have to do next is designate the replacement property you want to purchase. Once you do that, you can pass onto the final step As stated previously, you have 180 days from the sale of the old asset to complete the tax-deferred exchange.
Some personal property qualifies
The tax-deferred exchange is only for business assets, so how could you possibly use your personal possessions? While you cannot swap your primary residence for another one, you can exchange a vacation home for another vacation home. As you can see, there are exceptions to the rule. However, you have to be very careful because the IRS is very vigilant.