Creative entrepreneurs and investors dream up as many plans to grow their wealth as their imaginations allow. But only a narrow segment of those plans will fit through the special “like-kind” tax deferring provision built into the revised U.S. tax code.
Investors have been able to take advantage of the 1031 like-kind exchange for decades. Broadly, it lets them take proceeds from sale of one investment and apply it tax-free toward the purchase of one or more similar investments. Before passage of the 2017 Tax Cuts and Jobs Act, the 1031 exchange tax break stood open to a range of properties including aircraft and equipment. Now it’s closed to everything but real estate.
How to use the 1031 like-kind exchange
Structuring transactions as a 1031 like-kind exchange generally allows you to defer capital gains tax, but it comes with strict guidelines, some of which are mentioned here:
- The properties you sell and buy must be for commercial purposes: You may exchange a warehouse or apartment building for a ranch or undeveloped land, but it’s crucial that you use the properties for business purposes or hold them for investment.
- You have hard deadlines to find and close on new property: From the sale of your old property, you have 45 days to identify one or more properties that you will buy. You have 180 days from the sale of your old property to close on this new property.
- You must find a third party to handle the money: You cannot handle the money yourself. Instead, you need a qualified intermediary to receive and hold the funds. This is often a law firm and will prepare key documents for the IRS at both the sale and purchase.
- Your sides of the titles must match: The buyer’s side of the new property must show the same name as the seller’s side of the old one. If you’re selling and buying using entities, or if ownership otherwise differs between time of sale and time of purchase, this rule is easy to bust. Solid legal advice particular to your situation is important.
- You need to re-invest all the money: You can pay certain closing costs and direct the proceeds from the sale of your first property toward multiple new investments, but you must re-invest all the money to avoid capital gains tax.
There are other intricacies of 1031 exchanges, including provisions for reverse exchanges and construction or improvement exchanges. An experienced attorney can give you more details and help you explore the different ways a 1031 exchange might help you grow your wealth.
Taking advantage of the hottest markets
Business Wire reports that the market for Houston’s commercial property is going strong. That makes this a great time for new real estate investors to think about using a 1031 exchange to build their legacies. You’ll still need to make sound investments, but deferring tax can leverage your growth. As markets change, you can use like-kind exchanges to move your investments from one market or real estate category to another.