News For This Month: Taxes

Read This Before You Carry Out a 1031 Exchange

When you sell a non-inventory asset at a profit; the law requires you to pay capital gains tax on the transaction. With the exemptions in place, however, you can defer capital gains tax payments if you satisfy certain conditions. The disposal of property, for instance, attracts capital gains tax as long as a profit was involved. An exemption to pay capital gains tax arises when you use the proceeds from the sale to purchase another property, among other conditions. This simple exchange makes it possible to defer the payment of tax. Discussed next are some of the other conditions that you must satisfy to defer the payment of capital gains tax.

The new or replacement property must be held so as to take advantage of the exemption. If you later sell the property, you will be liable to pay capital gains tax. One desirable aspect is that you can defer the payment of capital gains tax indefinitely by swapping properties now and then.

Since the exchange involves business and investment property, you cannot benefit from an exemption if you intend to swap a residential building. You cannot, therefore, swap residential property in the hope of deferring the payment of capital gains tax. An exemption is possible when you swap your vacation home and satisfy the loophole applicable, but you will have to gauge if it is worth the trouble since the savings may not be substantial when you think about what you will be asked to do.

A delayed exchange is allowable since you may find it tough to get someone who is looking for your type of property and is swapping the exact property you are looking for. Here, a third party takes possession of the funds you received from the sale and acquires another property for you Even with third party involvement, a swap is still considered to have taken place.

You are required to identify the “replacement property” for the swap to be effective. It involves making the identification in writing, signing the document, and handing it over to a qualified intermediary before a 45-day period lapses.

An exchange is only valid if it involves properties of the same kind or type. The definition of like-kind in this instance is broad, meaning that you can sell an apartment and acquire raw land since they all fall under the classification of property.

The involvement of experts is necessary for a successful exchange to take place. The reason is that tax laws are complex and innumerable, making it easy to mess things up. Besides, tax laws change from time to time. An estate agent, attorney, accountant, and tax specialist can help you navigate the complexities involved.