What is a 1031 Exchange?
A 1031 Exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which permits you to avoid paying capital gains taxes when you sell an investment property. Instead of paying capital gains taxes, you can immediately reinvest all the proceeds from the sale in similar investment property of equal or greater value.
It is a tax strategy that allows investors to grow portfolios and increase net worth more efficiently. Congress passed the 1031 statute in 1921, and savvy investors have taken advantage of it ever since. Let’s review the basics of the 1031 exchange - how it works and some of its benefits.
You’re not eliminating capital gains taxes forever; you’re only deferring them. You can use the 1031 Exchange repeatedly as you upgrade investments, potentially deferring capital gains for many years. But whenever you cash out, the taxes on your profits are due.
What are capital gains? Capital gains are the increase in value of an asset from the time you purchased it to when you sell it. If you buy a property for $1,000,000 and sell it for $1,500,000, you have capital gains of $500,000.
Instead of paying taxes on your capital gains, you can use the proceeds from your sale as a down payment on a more valuable property, which immediately increases your cash flow and net worth.
The properties being exchanged must be considered like-kind in the eyes of the Internal Revenue Service (IRS) for the capital gains taxes to be deferred. Both properties involved in the exchange must be used for business or investment purposes. Personal or primary residences do not qualify.
There is a strict timeline you must adhere to. The IRS requires that new properties be identified within 45 days of the closing of the sale of the old property. You can identify up to three potential properties that you’d like to purchase, then you must close on one of them within 180 days of the sale of the first property.
There are several different scenarios involving 1031 exchanges, with each one having its own set of circumstances. I can help you with identifying, analyzing and buying/selling investment properties in New York City but you will also need to consult a CPA, an attorney, and a qualified intermediary to complete a 1031 Exchange.