1031 Exchange for Dummies: A Guide for Investors
Small business owners or Investors selling their commercial properties never end up getting as much as the buyers pay. You should cover the real estate agent’s commission, pay off your mortgage, and in some cases even the closing fees. One more thing often forgotten is the capital gains tax.
Depending on the income status and taxable income of the investor, the capital gains tax can add a tax on investor’s sales profits of up to 37%. Here we will help you in learning how to avoid this tax by reading our guide to 1031 exchange for dummies below.
1031 Exchange for Dummies: Defining a 1031 Exchange
The capital gains tax applies to the properties that the investor owns beyond their primary home, including a second home, or business property.
A 1031 exchange allows the investor or the taxpayer to avoid this massive tax when selling their property if he/she invests the funds into another non-primary home property.
This frequently overlooked loophole can easily save huge dollars when done correctly.
Steps for 1031 Exchange for Dummies
In order to perform a 1031 exchange, the investor need to follow some rules set by the IRS.
1. Qualify as a Like-Kind Property
The property chosen by the investor for investment must be of similar kind to the property the investor sells. Therefore if the property the investor sells is a trade or business property, then the property he buys with the profit must also qualify as a trade or business property.
2. Meet the 45-Day Window of Identification
There is an identification period of 45 days for the purchase or intend to purchase of new property for the investor. This counting starts as the first property sale closes. Even if the 45th day is a holiday, the investor has to submit his identified property.
3. Close within 180-Days
The investor has to close at least one of new property not more than 180 days after closing the sold property. The property purchased must be listed on the identified property list within 45-day identification period. So after that initial 45 days, you only have 135 days to close on your new property.
4. Hire a Qualified Intermediary
As a seller, the taxpayer is not allowed to use proceeds between the sale of the first property and purchase of a new one. You must hire an independent third party known as an intermediary or exchange partner to handle it. The qualified intermediary cannot be a family member or a business partner you worked with during the last two years.