Section 1033 of the tax code provides for the deferral of gain that is realized from an “involuntary conversion.” Such a conversion includes property that is destroyed in a casualty, property that is lost due to theft and property that is transferred as the result of condemnation or the threat of condemnation.

The principle or model of voluntary exchange assumes that people will act based on self-interests. This is an important component of a healthy economy. If individuals in a market economy do not feel that they will benefit from the exchange, they would not be willing to make it.

An involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and you receive other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called involuntary exchanges.

If an investor is required to relinquish their property through a “forced conversion,” the IRS provides an opportunity to defer capital gains taxes through the exercise of a 1033 exchange. This could exceed 20-30% of an investor’s proceeds received from the conversion. …

Any real property held for productive use in a trade or business or for investment can be considered “like-kind” property. The term refers to the nature or character of the property, rather than its grade or quality.

As mentioned, a 1031 exchange is reserved for property held for productive use in a trade or business or for investment. This means that any real property held for investment purposes can qualify for 1031 treatment, such as an apartment building, a vacant lot, a commercial building, or even a single-family residence.

five years

A second home or a vacation home held strictly for personal use with no rental activity at all is considered a second home, and does not qualify for the tax deferral benefits of a Section 1031 exchange. The mortgage interest and real estate taxes are tax deductions on Form 1040 Schedule A of the federal tax return.

Like-kind exchanges — when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind” — have long been permitted under the Internal Revenue Code.

There are a few simple rules of thumb to follow to avoid boot in a 1031 tax-deferred exchange:

1. Trade up in real estate value with one or more replacement properties.
2. Reinvest all of your 1031 exchange proceeds from the relinquished property into the replacement property.

Main Reasons Not To Do A 1031 Exchange

• You don’t mind paying taxes.
• You haven’t found the right property.
• You want to reduce exposure to real estate.
• You want to simplify your life.
• You’ve lived in your rental for at least two of the past five years.

Property Held for Investment Use The general rule is that you should not be living in any property that you wish to exchange with a 1031 transaction – though there are some exceptions to that rule.

The short answer. The direct cost to you in a 1031 exchange typically comes in the form of a fee paid to your QI. QI fees vary, but most reports indicate that a typical deferred 1031 exchange costs between $600 and $1,200.

Restrictions on 1031 Exchanges You can only perform a 1031 exchange between investment properties, but you can’t do this with personal property. It is possible to have both deferred and recognized gain in the same transaction when a taxpayer exchanges for like-kind property of lesser value.

The IRS statute requires that you use a qualified intermediary (QI) to perform your 1031 exchange. While it is possible for an attorney to provide this service, it doesn’t have to be an attorney and it can’t be an attorney you have utilized for any other matters.

Qualified Opportunity Zone Funds, allowed under the Tax Cuts and Jobs Act of 2017, are an alternative to 1031 exchange investing that offers similar benefits, including tax deferral and elimination. This fund option also works if you are selling other appreciated assets, like stocks or businesses.

A Deed, Bill of Sale, Invoice and or license are required to solidify the transfer of the exchanged properties. A Settlement Statement is required to illustrate the correct amount of funds coming into the exchange as well as proof the funds are appropriately being utilized to acquire the Replacement Property.

The main requirements for a 1031 exchange are: (1) must purchase another “like-kind” investment property; (2) replacement property must be of equal or greater value; (3) must invest all of the proceeds from the sale (cannot receive any “boot”); (4) must be the same title holder and taxpayer; (5) must identify new …

Normally a 1031 exchange is used to defer the capital gains tax owed by reinvesting 100% of the proceeds from the sale of a relinquished property into the new replacement property.

The 1031 Exchange Process – Step by Step

1. Delayed Exchange – Property is sold and replacement property is purchased within 180 days. Replacement property must be identified within 45 days.
2. STEP 1 – PLAN THE TRANSACTION.
3. STEP 2 – PURCHASE & SALE AGREEMENT.
4. STEP 3 – RELINQUISHED PROPERTY.
5. STEP 4 – REPLACEMENT PROPERTY.

In a 1031 exchange, a property owner can swap an investment property for another of a like-kind. To use the tax deferred strategy effectively, you have to buy a property of similar value to one you sell. In this way, you’ll avoid at least temporarily having to pay capital gains tax on the sale.

In real estate, a 1031 exchange is a swap of one investment property for another that allows capital gains taxes to be deferred. The term, which gets its name from IRS code Section 1031, is bandied about by realtors, title companies, investors, and soccer moms.

Broadly stated, a 1031 exchange (also called a like-kind exchange or a Starker) is a swap of one business or investment asset for another. Although most swaps are taxable as sales, if you come within 1031, you’ll either have no tax or limited tax due at the time of the exchange.

There are also states that have withholding requirements if the seller of a piece of property in these states is a non-resident of any of the following states: California, Colorado, Hawaii, Georgia, Maryland, New Jersey, Mississippi, New York, North Carolina, Oregon, West Virginia, Maine, South Carolina, Rhode Island.

Cash can be taken out of a 1031 tax-deferred exchange before, during, and after the exchange. Boot is another word for the cash taken out of an exchange that is subject to capital gains tax. Capital gains tax rates currently are set at 0%, 15%, or 20% depending on income level and tax filing status.

When performing a Section 1031 tax-deferred exchange, an exchanger may sell multiple relinquished properties in a single exchange, exchanging several properties into one (or multiple) replacement properties.