Who Should Think About Using a 1031 Exchange?

Deborah K. Vick

If you are in possession of real property that will provide you with a gain on the sale, you should evaluate whether a 1031 exchange is right for you. There are five different classes of taxes of property: property used in the trade or business of taxpayers, property being held for the purpose of selling to customers, property used as a primary residence, property used as a vacation home, and property held for investment.

1031 exchanges apply to both property held in the trade or business of a taxpayer and property held for investment, and in certain situations, property held as a vacation home. Bear in mind the following stipulations:

• Property held for immediate sale is not considered as an investment
• Business use can be defined as holding property for productive use in business or trade
• Property that is being retired from a prior “productive use” in business may qualify

There are many possible benefits of using a 1031 exchange, so long as you are clear on the best way to maximize your advantages. Examples of benefits include:

• Owning multiple buildings instead of just one
• Gaining leverage
• Deferring the payment of capital gains taxes
• Relocating to a new area
• Consolidating or upgrading buildings
• Obtaining relief from property management

The real property that you sell as well as the real property that you buy have to be held for productive use in a trade or business or for investment purposes, and they need to be similar. In order to get the tax benefits, the proceeds from the sale must pass through a qualified intermediary and not through your own hands- even briefly. If the funds pass through your hands at any point, any and all cash proceeds you obtain can be taxed.

There are many different kinds of properties that can be exchanged in this manner. “Like kind” refers to properties that are similar in character or nature. Examples of popular like-kind properties may involve commercial properties, condos, raw land, rental homes, duplexes, or apartments. Non like-kind properties are primary residences, notes, partnership interests, stocks and bonds, property to be resold immediately, or developed lots held for the purposes of sale.

You should never try to handle the funds associated with a 1031 exchange on your own. Doing so can eradicate the deferment of your capital gains tax and cause you to pay taxes, eliminating one of the major reasons that people seek out 1031 exchanges in the first place.

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