Section 1031 of the IRS Code allows an owner of eligible property to complete a tax-deferred exchange by purchasing “like-kind” replacement property with the property sales proceeds. Such a transaction potentially allows deferral of up to 100% of the capital gains taxes otherwise due on the property sale. The IRS defines “like-kind” as any property owned for business or investment purposes. This includes raw land, farmland, residential rental and commercial properties. IRS Section 1031 does not apply to the exchange of stocks or bonds.
Real Estate Taxes
Gains created by the sale of property are typically taxable at both federal and state levels. The following taxes may be deferred through a 1031 exchange:
- Federal capital gains – Up to 20%
- State taxes – As high as 13%, in some states
- Depreciation recapture – 25% of utilized depreciation
- Net income tax – 3.8%
This tax information is generalized, subject to change, and not intended as tax advice. Please consult with your tax advisor before beginning any 1031 property exchange transaction.
Benefits of a Like-kind Property Exchange
- Deferred capital gains tax
- Deferred depreciation recapture
- Wealth preservation potential
- Potentially greater net income
- Estate planning benefits
Completing a 1031 exchange
1
Engage a Qualified Intermediary to facilitate your property sale.
2
Sell your existing property. Cash proceeds are escrowed by your Qualified Intermediary.
3
Within 45 days after the sale of your original property, identify one or more replacement properties.
4
Within 180 days after the sale of your original property, purchase a replacement property, through your Qualified Intermediary, to complete your 1031 exchange.
Benefits of a 1031 exchange
A Delaware Statutory Trust (DST) allows a property seller to purchase a fractional interest in multi-property portfolios. The DST owns title to the properties for the multiple owners of the DST. For tax purposes, each DST investor is treated as owning an undivided fractional interest of the DST properties. IRS Revenue Ruling 2004-86 provides guidance on the use of a DST for property ownership.