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Understanding How a 1031 Exchange Works May End up Saving You Thousands of Dollars

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By : marco benavides    99 or more times read
Although a 1031 exchange offers many challenges, it also offers many rewards to investors. Real estate owners who have had property appreciate considerably during the time they have owned it may be looking for relief from capital gains liability. Depending on how much the property has appreciated and state and federal tax rates, it could mean paying tens if not hundreds of thousands of dollars. Rules and regulations on the Exchange of Property Held for Productive Use of Investment, can be found under U.S. CODE: Title 26, 1031.

This part of the IRS tax code states that transactions and exchanges under this section allow deferment of capital gains taxes. This is a legitimate way of putting off paying capital gains until it is convenient, and until it makes more financial sense for you to do so. There are generally accepted practice standards, rules and regulations and compliance with this section of the tax code is strictly enforced.

The rules and regulations give investors a 45-day identification period and a 180-day exchange period. If the tax return is due for the tax year when the transfer occurred before the 180-day time period, then the exchange period ends when taxes must be filed. This means that an investor could possibly have much less than 180 days.

Investors must remain constantly aware of the time guidelines because they are not working days. They are calendar days which count even if the last day falls on a national holiday or a weekend. The IRS strictly enforces the timelines and extensions are not usually granted.

Another aspect that the IRS strictly enforces is that the exchange property's purchase price must be equal to or greater than the net proceeds from the property being sold. If the price is less, then there will be a tax liability for the difference between the two prices.

An additional aspect that the IRS strictly enforces is that neither the investor nor his agent can control the proceeds from the sale. The money from the sale must go through a qualified intermediary or the entire proceeds will become taxable under Title 26, 1031. These are things that you definitely must keep in mind as you try to accomplish an exchange under this section.

Investors may be wondering whether it is really worth it going through all this trouble to execute a 1031 exchange. The answer would depend on the amount of income tax gain liability that the investor would incur by simply selling outright. If you bought property in the 1960's for a dance and a song and it has appreciated considerably during that time, then you may be better off opting for a 1031 exchange instead of having to pay hundreds of thousands of dollars in capital gains taxes.

It is up to the individual investor whether to consider a 1031 exchange. Although it may seem quite complicated, it really is not as long as you adhere to the rules clearly stated under this section. If you become familiar with this section of the tax code, you may reap some real rewards by being able to defer capital gains until some undefined time in the future.
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