Accounting 101 Real Estate Accounting Tax Policy

1031 Exchanges

A 1031 exchange is a powerful tool that allows real estate investors to defer the tax on any gain on the sale of an asset.

A 1031 exchange is a powerful tool that allows real estate investors to defer the tax on any gain on the sale of an asset by reinvesting the proceeds in a new property of equal or greater value.  If a property is sold, a new property must be identified within 45 days and purchased within 180 days. Additionally, no cash or debt can be assumed on the sale of the property, and the seller of the original property and the purchaser of the second must be the same person or entity. Keep in mind that a 1031 intermediary, usually an attorney or accountant, should be used to facilitate the transaction as they will be able to assist in properly carrying it out. It is important to defer these capital gains to be able to reinvest the full amount in a new property.

Time Frame

In order to qualify for 1031 exchange treatment, it is important to stick to the time frame required by law.  First of all, a new property must be identified within 45 days of the sale of the original property.  This property then must be purchased within 180 days of the original sale.  Without following this time frame, the taxpayers will be required to recognize a gain.  A 1031 exchange intermediary will assist in sticking to these strict deadlines.

Recognition of Gain?

In order to avoid recognition of a gain on the sale of the property, a 1031 exchange intermediary should be used to hold the funds from the sale of the property and facilitate the purchase of the new property.  No cash should be received for the original property, the value of the new property should be at least the same as the original property, and the debt incurred for the new property should be equal to or greater than the original property.  Lastly, the taxpayer, whether it is an individual, a partnership, or a corporation, must be the exact same taxpayer for both properties.  It is important that all of the owners of the taxpayer remain intact to avoid recognizing a gain.

Why Avoid a Gain?

Deferring a gain on the sale of an asset is extremely important while investing in real estate.  If a $100,000 short term gain I recognized on the sale of an asset, the tax liability could be $50,000 or more.  Instead of being able to reinvest that $50,000 in a new property, it needs to be sent to the government in the form of a tax payment.  That could make or break a new deal for an investor.

Summary

The 1031 exchange is an important tool for investors to be able to kick the tax bucket on any gain down the road to the future.  Although there are many requirements (find a property within 45 days, purchase within 180 days, and no cash received, among others), but this could allow a large chunk to be reinvested right away instead of sent to the government in the form of a tax bill.  A 1031 exchange is a complicated process, but it is a process that all real estate investors should be at least familiar with.

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