A 1031 Exchange is a tool that reduces your short-term tax liability when selling an investment property. The name comes from Section 1031 of the U.S. Internal Revenue Code and it allows the property owner to sell and buy like-kind property (properties of the same nature, no matter the grade or quality), within a given time period, while deferring capital gains or losses and the corresponding tax liability.

To qualify, a replacement property must be identified within 45 days of the replaced property sale. Once the property being replaced is sold, the investor now has 180 days to close on the new property. Tax deferment status requires that the investment purchased or sold cannot be resold or used for personal reasons within 2 years. Importantly, “Like-kind” properties can take a variety of different forms. For example, vacant land can be exchanged for a commercial building or an industrial property can be exchanged for residential.

Proceeds from the sale of the first investment property must be transferred to a qualified intermediary (person or company who facilitates the 1031 exchange by holding the funds until they can be transferred to the seller of the new investment property). Without this intermediary, any proceeds received from the sale remain taxable. When the new like-kind property is purchased, the intermediary transfers the funds to the seller of the new investment property.

Why Should Investors Use a 1031 Exchange?

This is a great option for real estate investors looking to upgrade to a property that is larger and/or in better condition. Commonly, an investor may utilize this tool as a means of consolidating several smaller properties into a larger one for easier management, or dividing a larger property into several smaller assets. It also offers an opportunity for an investor to multiply returns by finding a better investment.

Another reason investors may want to use a 1031 Exchange is to reset depreciation on their property. Depreciation is the portion of the assets value that is written off every year for tax purposes. Essentially, this is meant to account for wear and tear on the property over time by distributing the depreciable costs across the useful life of the property. Typically the costs of buying and renovating a rental property are deductible as well.

If you are interested in learning more about how a 1031 Exchange could help you, feel free to reach out to cam@csluxurygroup.com, 617.869.1750, or message us on any social platform!