1031 Exchange: The Best Option For Real Estate Investors

Real estate has been termed as the foundation of wealth, currency and value, which shall never crash. The fundamentals of real estate business are derived from the perceptions of risk inherent in the game. It is an accepted financial axiom that when one takes higher degrees of risk, then the potential and returns increase as well. The real estate industry has witnessed a sea of revolution over the last decade with a substantial widening of the gap between the generally held perceptions of risk and the actual risk in a transaction.

Financing and taxes are the two factors that have worried the buyers and sellers in any real estate transaction. Creativity and negotiating skills can help buyers obtain more favorable financing terms and being aware of like-kind exchange opportunities can help sellers with tax consequences. Section 1031 of the Internal Revenue Code in US provides one of the best strategies for the deferral of capital gains taxes, which would ordinarily arise from the sale of real estate. The term "1031 exchange" refers to Internal Revenue Code Section 1031, which allows real estate investors to sell an investment property and buy replacement investment property without paying capital gains tax on the profit from the sale. The capital gains tax liability is not eliminated; it is merely deferred until the investor ultimately sells out for cash. That's why a 1031 exchange is also called a tax-deferred exchange.

There are significant tax benefits to selling real estate as part of a like-kind exchange. The like kind exchange can be categorized into two types: a simultaneous exchange where a seller sells real estate and invests the proceeds in other real estate, or a deferred exchange in which real estate is sold, the sale proceeds placed in escrow with a qualified intermediary, and the proceeds then used to purchase replacement real estate within the time period prescribed by the Internal Revenue Code. In a tax-deferred exchange, the replacement property must be of equal or greater value than the property being sold, and the mortgage on the new property must be of an equal or greater amount than the existing debt on the property being sold. Any excess cash that ends up in the exchanger's hands at the end of the deal is called boot and becomes taxable income.

The foundation of 1031 exchange rule is that the properties involved in the transaction (the property to be sold and the property to be bought) must both be held for productive purpose in trade or business or as an investment and they must be like kind. This is one of the most misunderstood concepts in 1031 Exchange. Like Kind relates to the use of properties and not to the location or description of it. Any property used to produce income qualifies as like kind to other income-producing property.

The basic requirements of a 1031 Exchange can be enumerated as follows:

· Both the property to be sold and the new property to be acquired have to be of like kind.

· The IRC requires that the new replacement property be identified within a span of 45 days of the closing of the sale.

· Section 1031 requires that one or more of the new like kind property is purchased by the 180th day of the closing of the sold property.

· A Qualified Intermediary (QI) has to be used for 1031 tax deferred exchange transaction.

· Section 1031 requires that the taxpayer on the old property be the same taxpayer on the new property.

· In order to defer 100% of the taxes on the gain of the sold property the new property must be of equal or above the value of the sold property.

1031 Tax Deferred Exchange allows the real estate owner to exchange management-intensive property for quality property with the potential to generate a larger income, increase tax benefits and appreciation potential. Exchanging defers the recognition of the capital gains tax, leaving the property owner with substantially more proceeds to purchase a replacement property. Ultimately, the exchange process allows investors to reorganize and improve their real estate portfolios to best suit their unique interests and needs. With the World Wide Web creating a platform for sharing information related to real estate, numerous websites have been created where one can acquire knowledge about 1031 tax deferred exchange, like-kind property exchange, qualified intermediaries, 1031 tax exchange boot, tenants in common and triple net lease and more.