How to Use the 1031 Deferred Tax Property Exchange

A 1031 tax deferred property exchange is a vehicle used by those who deal regularly in real estate transactions. This tax break is available to those who are selling income producing real estate or vacation property in one area with the intent to purchase similar property elsewhere. If a capital gain is going to be realized, this tax deferral can save the investor many tax dollars.

The regulations that govern these transactions are very explicit and require a knowledgeable person to guide the process. Many companies today specialize in this type of real estate action. The main problem for most people is trying to satisfy the time requirements for getting one property sold and its replacement located and purchased.

The law states that you have only 45 days to identify and record up to 3 replacement properties after the initial property is sold. The profits from the first real estate deal have to be put into an escrow account with an approved agent. The funds are held and can only be used for earnest money until the closing for the replacement property. The entire deal start to finish has to be completed within 180 days of the first closing date.

Rental property cannot be exchanged for a vacation home. Commercial property cannot be exchanged for residential rental property. The idea is that the new property must be of the same purpose as that which was originally sold. This means that it is important that such property be available in enough quantity to assure that replacement property can be purchased relatively soon after the first property sells.

The price range of the new property is tied to the sale price of the first property. The purchase price cannot exceed 200% of the sale price. The replacement property must cost at least 95% of the original property’s selling price.

While this seems like a wide range, when coupled with the time requirements, getting a 1031 tax deferred transaction to work out can be quite difficult for the novice at this procedure. Companies that have become agents to work with the IRS in holding the funds and filing the various paperwork involved are able to help smooth the rough places on many of these deals.

Getting the interim paperwork filed on a timely basis is a big deal. If you miss that 45 day deadline, the 180 day deadline is dead on arrival. The best bet is to do your full research and have properties located before marketing the original real estate.

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