How to Use a 1031 Exchange to Buy an Investment Property

You may have heard of someone who used a 1031 Exchange to purchase a property. They are used for investment properties and it will help you avoid having to pay immediate capital gains taxes on the sale of an investment property. So how does it work and could it work for you?

What is a 1031 Tax-Deferred Exchange?

How to Use a 1031 Exchange to Buy an Investment PropertyInternal Revenue Code, Title 26, Section 1031 says: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”

That means it allows a tax deferred exchange of like-kind properties along with cash, liabilities and property. All kinds of entities can take advantage of it, individuals, C corporations, S Corporations, partnerships (general or limited) limited liability companies, trusts and any other taxpaying entities.

Like-kind relates to use:

Like-kind relates to the use of properties, and that means that the old and new properties must be held as an investment or used in a business. Vacant land is always considered as qualifying for 1031, but “flip” properties and primary residences don’t qualify. While investments are eventually going to be sold, a 1031 requires a two year holding period.

No extensions allowed:

The new property must be identified within 45 days of the closing of the sale of the old property and there are no extensions. The 200% rule requires that the total value of all of the properties that you are identifying to be less than double the value of the property that you sold. The closing on the new property must take place within 180 days of the closing on the old property. Again, there are no extensions for any reason. The money from the sale of the old property can’t be touched by the seller either. A Qualified Intermediary is required to hold it for the seller until closing on the new property. Also everyone listed on the title to the old property has to be listed on the new one as well and the new property has to be the same price as or a higher price than the old one.

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