1031 Exchange is a favorite buzzword in the investment world. It signifies that you can exchange one asset for another one. This would be tax deferred or comes with limited tax. Though most of the exchanges would be taxable, when you come within 1031 Exchange range it would call for a “little or no tax to be paid” scenario. The benefit of this is that you can grow your investment without worrying about taxes. And the good news is that there is no limit to the number of times you can make the swap. You can keep rolling over your investment for another without paying capital gains taxes, unless you decide to sell the property for cash at any time.
Beware: While dealing with depreciable property, you might trigger depreciation recapture. In normal cases, the swapping is done between land or between buildings. But when the exchange is between improved land (with building) and unimproved land (minus building) the depreciation you had earlier claimed on the other building would be recaptured as ordinary income.
Dealing with 1031 Exchange could be a complication that would be best resolved with the help of a competent professional. Even so, here are certain basic facts about it to help you gauge a better understanding:
1031 Exchange is not for personal use, but it comes with strings attached
1031 Exchange is applicable only for business investments. There are some ways in which you can exchange vacation homes, but there are loopholes; seek a professional to help you with this. However, if you are planning to exchange a painting or a similar item, then 1031 Exchange works. Partnership interests or corporate stock doesn’t apply here.
Three-party exchanges work
Sometimes, it becomes impossible for you to find an appropriate property to exchange. In such cases, you can find someone to help you “sell” the property and hold the cash. And when you find a property that suits your requirements, the person will buy it for you. Such an exchange would be delayed and is known as Three-party exchange.
What you can exchange
It is possible to exchange “like-kind” properties. For example, you can exchange your land for a ranch; be aware of the rules that may waylay you, though.
The closing time is 6 months
We talked about delayed exchanging, but there is a time-limit. Your new property should be “bought” within 6 months of selling the old one.
1031 Exchange is possible in these conditions. However, no gain or loss will be recorded through 1031 Exchange for like-kind properties. Such a property can be used for trade or business purposes. The idea is to defer capital gains taxes while facilitating a significant investment property.