Investment Property Exchange: 1031 Exchange Investors Be Aware of 2021 Tax Deadlines
In real estate investing, taxes can wipe off a significant chunk of profits on your investment. As an investor, you will probably want tax breaks and advantages to help make the most out of any real estate investment.
A 1031 exchange offers investors one of those tax advantages. 1031 exchange is a swap of an investment property for another that allows you to defer capital gains taxes on the property. This arrangement lets you defer the tax liability on the sale of a property by using the proceeds from the sale to acquire a new property. The idea regulating a 1031 exchange is that there is no taxable income on a property if you did not receive any payment for the property.
1031 exchange gets its name from Section 1031 of the Internal Revenue Code (IRC), allowing investment property owners to defer taxes on some real estate exchanges. There are pretty complex rules governing the 1031 exchange, so you want to meet the requirements before deciding on a property swap. Investors also need to understand 1031 exchange timelines, as these can become a problem if applied inappropriately. You can use a 1031 exchange for as long as you want, allowing you to defer payment on capital gains taxes indefinitely. This article will help 1031 exchange investors be aware of 2021 tax deadlines and rules.
Understanding 1031 Exchange Rules
There are rules, guidelines, and concepts you must understand before effectively using the 1031 exchange. There are two kinds of taxes you may need to pay on an investment property sale – capital gains tax and depreciation recapture.
Capital gains tax comes in if you made a profit on the sale of an investment property i.e., you sold the property for more than you purchased it. Assuming you bought a property for $200,000 and sold it for $230,000, you have will have made $30,000 in capital gains and have to pay capital gains taxes on the $30,000 if you’ve held the property for more than one year.
Depreciation is the percentage cost of an investment property written off each year with respect to the effects of wear and tear on the property. Depreciation recapture is a type of tax that offsets the deductions on the depreciation you can claim each year. Residential rental property depreciation is calculated over a 27.5-year period, so your $200,000 property will get an annual deduction of $7,273. Depreciation recapture is a vital factor when calculating property value in a 1031 exchange.
Like-kind Property Rule
In a 1031 exchange, you can only swap properties having the same “nature” or “character.” This does not mean swapping precisely the same properties. It only means that the replacement property must be one you intend to hold for investment. You cannot sell an investment property and acquire a residential property for your family using the 1031 exchange. Both properties must be used as investment assets. You may need to speak with an expert if you are unsure whether an asset qualifies as an investment property.
1031 Exchange Time Limits
Using the 1031 exchange is not as straightforward as selling an asset and purchasing the next one. The IRS set time limits on the 1031 property exchanges.
As per IRC guidelines, an investor has 45 days from selling a property to identify suitable replacement properties. The investor can pick out up to three like-kind replacements or as many as possible if their combined value is not more than 200% of the original property sale price.
You can apply for a 1031 exchange 45-day rule extension if you cannot find a replacement property within that timeframe for one reason or another. The section 1031 exchange timeline also mandates the process to be completed within 180 days. This means that the investor has 180 days from the sale of the property to close in on a replacement property purchase.
In response to the coronavirus pandemic, the IRS announced a 1031 exchange time limit extension in 2020 to provide relief to taxpayers who could not meet up with their deadlines. The IRS continues to issue guidelines to help 1031 exchange investors be aware of 2021 tax deadlines.
You can find a replacement property quickly by speaking to a local broker, working with a real estate professional, or checking on real estate websites.
Reverse Exchange
If you identify an investment property to buy before finding a buyer for your original property, you can perform a reverse 1031 exchange. This means that you have a 45-day time limit from when you purchased the property to identify the property you want to sell and 180 days from the purchase date to close the sale and complete the exchange.
Simultaneous Exchange
Two investment property owners can swap their property and register it as a 1031 exchange. A simultaneous 1031 exchange allows an investor to sell one property and buy another at the same time. A third-part exchanger can also facilitate a 1031 exchange between two investment property owners.
How to Use Section 1031
Here are general steps involved in performing a 1031 exchange:
- Identify the property you wish to sell
- Get professional help in facilitating the exchange. The 1031 exchange process can get complicated quickly, and you want an expert in your corner when this happens.
- Include a section stating your intention to use the property for a 1031 exchange in any offer you receive.
- Identify up to three potential replacement properties within 45 days of finalizing a sale.
- Decide on the property you want to purchase draw up a purchase contract.
- Make your offer and close on the replacement property with 180 days of selling the property.
- File the relevant IRS forms reporting the exchange on your tax returns. You may need a 1031 exchange professional or a tax attorney to help you with this process.
Conclusion
1031 exchange provides an opportunity for real estate investors to defer capital gains tax for as long as possible while building their portfolios. The exchange process is not often simple, and you may need professional help in many cases. It also helps to be on the lookout for guidelines released to help 1031 exchange investors be aware of 2021 tax deadlines and inform their decisions.
