What is a Tax-Deferred Exchange?
- Date: 2007-06-25 - Word Count: 446
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It is nice to make a lot of money on an investment such as real estate. However, if you do not know about the opportunity for a tax-deferred exchange, you might end up giving a lot of your profit to the taxman.
The United States Internal Revenue Code has a provision known as the 1031 Exchange or as it is sometimes called, a Like Kind Exchange. This provision is usually used for Real Estate transactions, but it certain cases, it can be used for personal property as well. What the 1031 Exchange does is allow you to defer the tax liability on an investment by reinvesting the proceeds from the sale into a similar investment within a certain time limit.
For example, if you purchase a Real Estate property for productive business use or for investment and your property appreciates by a considerable amount, you can sell the property and avoid paying the capital gains tax. In order to do this, you must select and identify a similar property within 45 days of the closing of the sale and actually close the sale on the new property within 180 days.
Usually, the proceeds from the first sale are held by a designated third party known as a Qualified Intermediary. When it is time for the closing on the new property, the Qualified Intermediary transfers the funds to the closing agents. As long as the new property is of similar type and value and the time limit is met, no tax is paid of the profit from the sale. The idea behind this provision is that the gains are not actually realized, but just transferred to a new investment.
It is important that the new property be of equal or greater value. If you "trade down", there will be a tax liability on the funds left over after the second transaction is completed. It is also important that the time limits are met. The IRS is unforgiving of any delays and will not extend the time limits for any reason. Even if the 180th day falls on Christmas day, you will not be given an extra day. If you fail to meet the deadline, the capital gains tax will be owed.
The 1031 Provision does not forgive the tax debt on the gain. It really only defers it until a later time. This idea of tax-deferred transactions are similar in principle to the 401K type retirement plans in that they allow you to put off the payment of tax until a time when the circumstances will be more favorable to take the profit as income and allow it to be taxed.
Sell your own home with a free one month listing at FSBOAmerica.org
The United States Internal Revenue Code has a provision known as the 1031 Exchange or as it is sometimes called, a Like Kind Exchange. This provision is usually used for Real Estate transactions, but it certain cases, it can be used for personal property as well. What the 1031 Exchange does is allow you to defer the tax liability on an investment by reinvesting the proceeds from the sale into a similar investment within a certain time limit.
For example, if you purchase a Real Estate property for productive business use or for investment and your property appreciates by a considerable amount, you can sell the property and avoid paying the capital gains tax. In order to do this, you must select and identify a similar property within 45 days of the closing of the sale and actually close the sale on the new property within 180 days.
Usually, the proceeds from the first sale are held by a designated third party known as a Qualified Intermediary. When it is time for the closing on the new property, the Qualified Intermediary transfers the funds to the closing agents. As long as the new property is of similar type and value and the time limit is met, no tax is paid of the profit from the sale. The idea behind this provision is that the gains are not actually realized, but just transferred to a new investment.
It is important that the new property be of equal or greater value. If you "trade down", there will be a tax liability on the funds left over after the second transaction is completed. It is also important that the time limits are met. The IRS is unforgiving of any delays and will not extend the time limits for any reason. Even if the 180th day falls on Christmas day, you will not be given an extra day. If you fail to meet the deadline, the capital gains tax will be owed.
The 1031 Provision does not forgive the tax debt on the gain. It really only defers it until a later time. This idea of tax-deferred transactions are similar in principle to the 401K type retirement plans in that they allow you to put off the payment of tax until a time when the circumstances will be more favorable to take the profit as income and allow it to be taxed.
Sell your own home with a free one month listing at FSBOAmerica.org
Related Tags: property, real estate, exchange, home, tax, homes, taxes, 1031, irs, deferred, like kind
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