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A 1031 exchange refers to Section 1031 of the U.S. Internal Revenue Code allowing an owner of an investment property the ability to reinvest in a different property of “like-kind” without triggering capital gains until the final exchange of a piece of property is sold. This deferment can be used for multiple investment properties, one after the other, with capital gains owed when the final property is sold, typically at a long-term rate.
The IRS is very clear about guidelines for 1031 exchange properties. One crucial requirement is that both the relinquished and the replacement properties be intended and used as investment properties for them to qualify for 1031 tax deferment. But what is not so clear is how long you must hold either property in order to meet qualification requirements. The only holding requirement is that both properties be held for a “sufficient period of time” which leaves it up to interpretation should there be a potential problem.
Sishodia PLLC, New York real estate attorney Natalia Sishodia, and our experienced Manhattan 1031 lawyers can guide and advise in setting up a 1031 exchange. The rules concerning 1031 exchanges can be strict. Getting the help of an experienced New York City 1031 lawyer can help you sell and buy properties simultaneously and explain how to defer taxable gain on property. To schedule a free consultation, call us today at (833) 616-4646.
How Do 1031 Exchanges Work?
The Internal Revenue Code Section 1031 allows investors and business owners the ability to trade property for “like-kind” property. This is a way to defer capital gains tax arising from the sale or purchase of investment property. The proceeds of the sale may be used to purchase “replacement” property.
In order for the exchanger to defer capital tax gains and satisfy the requirements of 1031, he or she must transfer the proceeds of the sale of the first investment property or the “relinquished” property to a qualified intermediary (“QI”). All tax benefits under 1031 will be forfeited if the exchanger seizes the sale proceeds.
A 45-day rule applies after the relinquished property is sold. This means that the exchanger has 45 days to notify the qualified intermediary of properties that will be potential replacements. These replacement properties will qualify for the exchange.
The 1031 exchange also has a 180-day rule where the exchanger must have the replacement property received within (1) 180 days of the sale of the relinquished asset or (2) the due date for filing taxes (including extensions) in the tax year that the relinquished asset was sold.
It is important to speak with an experienced real estate attorney when dealing with 1031 exchanges. A skilled attorney may be able to help you understand your rights and responsibilities in the transaction.
| Topic | Details |
|---|---|
| What is a 1031 Exchange? | Allows investors to trade property for “like-kind” property to defer capital gains tax from the sale or purchase of investment property. |
| Process Overview | Transfer sale proceeds to a qualified intermediary (QI). Notify the QI of potential replacement properties within 45 days of relinquished property sale. Acquire replacement property within 180 days of relinquished property sale or tax filing due date. |
| 45-Day Rule | Exchanger has 45 days to identify potential replacement properties to the qualified intermediary. |
| 180-Day Rule | Exchanger must acquire replacement property within 180 days of relinquished property sale or tax filing due date. |
Your Intention in a 1031 Exchange is What Matters to the IRS
Time is only one factor that the Treasury Department will consider when they are investigating a situation involving a 1031 exchange. While holding time may be considered a factor, they are primarily concerned with the use of both properties, not the length of time they have been held.
The IRS has taken the position that if you purchased your relinquished property just before your 1031 exchange transaction, the intention of the purchase was not for investment but instead for sale. They have also taken a similar stance if the replacement property is not held long enough to be considered “sufficient” that it was not intended for investment.
Consequently, as an investor who is interested in a 1031 exchange, you will want to fully understand the implications of your purchases and the exchange. If questions arise, you will need to be able to prove that both properties were truly intended as investments. The longer a property is held with supporting evidence of income, the stronger your case will be if the IRS has questions about your intentions.
If you hold 1031 properties and want to know more about how long you need to hold on to them before selling them, consulting an experienced 1031 lawyer may be helpful. A skilled 1031 attorney may be able to give you legal advice on what your next steps should be.
A 1031 Exchange Holding Period is Case-By-Case Basis
The IRS investigates 1031 exchanges on a case-by-case basis. While there are no definitive rules on a holding period for a 1031 exchange property, it has made rulings indicating that a holding period of two years has been considered sufficient in order to meet the qualified use test. Other court decisions have even been more liberal.
In addition, many tax advisors recommend that owners of 1031 exchange properties hold them for a minimum of one year and maintain other proof of rental income, depreciation, expenses, and other supporting evidence of its use as an investment property. If you plan to eventually use your replacement property as a second or primary home, it must also fit IRS’s safe harbor rule with its own requirements.
1031 Exchange Time Limit
In a like-kind property exchange, you’re not required to switch properties at the same time. However, if two-time limits aren’t met, it can result in the entire profit being subject to taxation. The sole exception to this rule is in situations of disasters declared by the president.
From the day you sell your initial property, a 45-day time limit is granted to identify potential replacements. This identification process involves penning a written note, signing it, and directing it to a participant of the exchange – this could be either the seller of your replacement property or an intermediary qualified for the task. Simply informing professionals like lawyers, realtors, or accountants who act on your behalf is not enough.
The written identification should precisely describe the replacement properties. For real estate, relevant details such as a legal description, a clear street address, or a distinct name must be included. Ensure to align this process with the guidelines set by the IRS concerning the allowable number and valuation of the properties you’re looking to identify.
The secondary time limit states that you need to acquire the replacement property and finalize the exchange within 180 days of selling the original property or by the deadline (inclusive of any extensions) of your tax return for the year the first property was sold – whichever comes first. The replacement property acquired must closely resemble the property that was designated within the initial 45-day timeframe.
Navigating the intricacy of a 1031 exchange time limit can be a daunting task. At Sishodia PLLC, our skilled New York City 1031 exchange lawyer can understand the urgency and complexity associated with 1031 exchanges, ensuring that deadlines are met and opportunities are maximized. With in-depth knowledge of IRS regulations and local market dynamics, we provide tailored strategies to secure your investments’ seamless transition while adhering to the time constraints. Contact us today to schedule a consultation.
1031 Exchange 5-Year Rule
Understanding the intricacies of real estate and tax legislation can be challenging, particularly when it pertains to the 1031 Exchange, a provision that permits investors to postpone paying capital gains taxes when they exchange similar kinds of properties. However, it’s important to grasp the 5-Year Rule established by the American Jobs Creation Act of 2004.
This rule has significant implications for those wishing to transform a property obtained via a 1031 Exchange into their primary residence. According to the tax regulations under IRC §121, individuals can exclude a gain of up to $250,000 (or $500,000 for married couples filing together) from their taxable income when they sell their primary residence, on the condition that they’ve both owned and occupied the home for a minimum of two out of the last five years before the sale.
However, when the property in question was initially acquired through a 1031 Exchange, to benefit from the tax exclusion on the subsequent sale of the property as a personal residence, the owner must not sell the property within five years following the exchange. This provision effectively seals off a previously common strategy that allowed investors to convert rental or investment properties into primary residences, reside in them for two years, and then sell them without incurring tax liabilities, only to repeat this process again.
It’s noteworthy that the 5-Year Rule doesn’t necessitate the owner to reside in the property for the entire five-year span. The requirement is to maintain ownership for five years while residing there for a total of at least two years within that timeframe to qualify for the exclusion of gain.
The introduction of this rule serves to deter investors from rapidly flipping investment properties, while still providing a legitimate avenue for tax exemption for those who earnestly transform their investment properties into personal homes. For investors, a clear understanding of this stipulation is essential for careful long-term planning and to fully leverage the advantages of their property investments.
1031 Exchange Properties – Capital Gains Tax and Deadlines
Deadlines are important for 1031 exchanges. Investors must find replacement properties for their assets within 45 days and close on these properties within 180 days. Failure to meet these deadlines could lead to a disqualified exchange.
Investors who are unsure how long they will have to keep their replacement assets in order to sell them might be better off tweaking their exchange strategy. This isn’t time, but intention.
IRS Code Section 1031 describes the various rules regarding 1031 exchanges. The code does not specify how long exchangers must keep their replacement assets. The code does say that an exchanged property held for sale is not a like-kind swap. This means that Investors cannot sell one investment property and complete a 1031 exchange to defer capital gains, then fix and flip the replacement asset.
You must acquire replacement assets with the intention of using them as investment properties. In a 2009 IRS ruling, the IRS stated that exchangers will not realize any gain or loss when exchanging one property for another that is similar in nature.
In the same ruling, the IRS also addresses the issue of “holding requirements”. There is no time limit, but language that addresses the exchange’s intent is used.
Getting Legal Advice For Your Properties from an Experienced Real Estate and 1031 Exchange Lawyer
While 1031 exchanges can offer an investor great benefits, they can also be complex transactions. If you are considering a 1031 exchange, you will want experienced guidance to ensure that you are not disqualified and face stiff capital gains or other penalties.
At Sishodia PLLC, Natalia Sishodia and our team of highly experienced New York City real estate attorneys know 1031 exchange laws inside and out and will help you navigate the process while avoiding making critical mistakes. Contact us at (833) 616-4646 or through our online contact form to see how we can help.
