Internal Revenue Code Section 1031 enables property owners to defer capital gains on the sale of business use or investment property provided another business use or investment property is acquired in the same transaction. A 1031 exchange allows investors to accomplish many investment goals, such as acquiring property with greater income potential, relocation of an investment property and diversification.
Some of the requirements of a successful 1031 exchange are as follows:
• A qualified intermediary is required to facilitate the exchange. The qualified intermediary acquires, holds and conveys both properties, controls the sale proceeds and guides the exchanger through the exchange process.
• The exchanger must not have actual or constructive receipt of the sale proceeds, including deposit monies.
• Once the relinquished property is conveyed to a buyer, the exchanger has 45 days to identify replacement property and a total of 180 days to acquire it.
• To maximize the tax-deferral, replacement property of equal or greater value and equity must be acquired. In the event of a trade down in value or equity, the exchanger is taxed on the amount of the trade down.
• Title to the replacement property must be held in the same name as the relinquished property.
In addition to the investment objectives already mentioned, a 1031 exchange is a great estate planning tool. The fact that one may complete exchange after exchange and continue to rollover the gain allows the gain to be deferred indefinitely. Upon the death of the exchanger, the heirs inherit the property with a stepped-up tax basis thus eliminating all deferred gain.
While real estate exchanges account for a majority of 1031 exchanges, you can exchange any type of asset held for business use or investment, including tangible and intangible assets. A few examples include airplanes, construction equipment, rental car fleets, artwork, patents, race horses, distribution rights and livestock. When exchanging personal property, “like-kind” replacement property must be acquired which means something within the same asset class. When exchanging, in addition to deferring the capital gains, you also defer the depreciation recapture. For business owners who took bonus depreciation in recent years, this is especially beneficial and helps keep valuable capital invested in the business.
Business owners have long utilized 1031 exchanges to help grow their business. They can also help a business relocate to a better location or a more efficient facility or expand into several locations as well as replace equipment and vehicles. Additionally, exchanges can provide an exit strategy for retiring business owners by exchanging business related real property for other incoming producing real estate or even a future vacation home or primary residence.
If you are considering selling real property held for business use or investment purposes, be sure to contact Gregory J. Spadea of Spadea & Associates, LLC at 610-521-0604 to discuss how you might benefit from a 1031 tax-deferred exchange.