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Understanding the 1031 Exchange

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By : Roby Hicks    99 or more times read
It is important to understand the 1031 Exchange first because you can definitely take advantage of it. Using this strategy will help you earn more. This method is also known as tax deferred exchange. As the name suggest, this is an exchange, which takes place when an individual sells a property and buys another. This is similar with the typical sell and purchase of a property. However, unlike the said transaction, an exchange will not require the payment of the property tax gain. This is duly explained in the Internal Revenue Code under Section 31. This also follows the regulations of the like-kind exchange.

There are different requirements that have to be followed before the transaction can be recognized as an exchange. It is important that such requirements are met to do away with the capital gain tax, which amounts to about 20-30%, depending on which State you are in.

Although there are several factors you need to follow, there are two important things you have to bear in mind. These are:

  • The value of the replacement property should be equal to or more than the value of the property sold.

  • Additionally, the proceeds from the selling of the property should be used entirely for buying the replacement property.

The above mentioned requirements have to be met. If any of them are violated, there will be appropriate tax consequences. First, if the value of the replacement property is less than the value of the relinquished property, the difference of the two values will be taxed.
Here, the partial exchange takes place. Only the excess value is taxed. Here, the executing individual may for the partial tax deferral treatment.

You also have to keep in mind that the properties involved have to qualify. Both the relinquished and the replacement property should be used for productive purposes. This means that only the investment properties can qualify. You also have to bear in mind that there is a need of a Qualified Intermediary (QI). The proceeds of the sale of the relinquished property should go through him. Additionally, it should also go through you or your agent.

The transaction also follows a strict timeline. There is a timeline for the identification of the replacement property as well as time that the exchanging individual is supposed to receive the replacement property. The timeline for identifying a replacement property is 45 days after selling the relinquished property. The 45 days timeline should be strictly followed even if the 45th day falls on a holiday.

Another period that is strictly followed is the Exchange Period. This is the time when the replacement property is transferred to the individual executing the exchange. This should take place in 180 days after the transfer of the relinquished property. It could also be during the due date of the tax return where the exchange is recognized, whichever is earlier. This should also be followed even if the 180th day is a holiday.

The 1031 Exchange is a good strategy to apply as this will definitely benefit you.
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