What Is a 1031 Exchange? Things You Need to Know
A 1031 exchange, named after Section 1031 of the U.S. Internal Revenue Code, allows real estate investors to defer capital gains taxes by reinvesting proceeds from the sale of one investment property into another “like-kind” property. This strategy is commonly used to grow wealth and portfolio value over time. Traditional Abstract provides 1031 exchange in Allentown, Bethlehem, PA, Easton, PA, Lehigh Valley, Nazareth, PA and surrounding areas.
Key Things You Need to Know:
Like-Kind Property
The properties involved must be similar in nature and use. In real estate, most investment properties qualify as like-kind—even if they differ in type (e.g., swapping a commercial building for a rental home).
Investment or Business Use Only
Both the relinquished and replacement properties must be held for investment or productive use in a business. Primary residences and properties intended for personal use do not qualify.
Strict Timelines
Timing is crucial. After selling the original property, you have 45 days to identify potential replacement properties and 180 days to close on the new property.
Same Taxpayer Rule
The taxpayer who sells the relinquished property must be the same one who buys the replacement property. This includes ownership structure (e.g., individual, LLC, trust).
Use of a Qualified Intermediary (QI)
The proceeds from the sale must be held by a qualified intermediary—not the seller. The QI facilitates the exchange and ensures compliance with IRS rules.
Tax Deferral, Not Elimination
A 1031 exchange defers taxes but does not eliminate them. Taxes are due when the replacement property is sold without another 1031 exchange.
Potential for Estate Planning
If the investor holds the property until death, heirs may receive a “step-up” in basis, potentially eliminating deferred taxes.
Final Thoughts
A 1031 exchange is a powerful tax-deferral tool for real estate investors, but it comes with complex rules. Consulting with a tax advisor or real estate attorney is essential to ensure full compliance and maximize benefits.
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