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Real Estate Investment: Should I use a 1031 Exchange Tax Deferment Tool?

Franklin Delano Roosevelt once said that “real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid in full, and managed with reasonable care, it is about the safest investment in the world”. While some may not agree with FDR after the recent housing recession, millions of real estate investors regularly turn profit on investments when done correctly. One tool to assist with real estate investing is the 1031 exchange.

A 1031 exchange is a method in which a seller can defer the tax liability, on any profits made in the transaction, by exchanging a “like-kind” property. In such a scenario, an investor sells real property by making the 1031 exchange election and then within a prescribed time frame must purchase another similar property. If all requirements are met, the investor’s tax liability will be deferred to a later date.

It is important to note that only investment property qualifies for a 1031 exchange. Primary homestead and properties intended as vacation homes will not qualify for the deferment. It is also important to recognize the distinction between tax deferred and tax exempt. To be clear, 1031 exchanges are a tax deferral vehicle; they are not tax exempt.

Further, in order to qualify for the deferment, the property must be exchanged through an intermediary. A popular misconception is that a seller may sell one property and then turn around and invest the money in the purchase of another property. However, that is incorrect and can subject a seller to taxation on the entire amount of gain. In a 1031 exchange, the seller must choose an intermediary to complete the transaction. The intermediary must be an independent party who holds the funds and works with the title companies to complete the transactions. Given the amount of trust involved here, it goes without saying that the intermediary should be chosen carefully.

Finally, there are strict time frames a seller must comply with in order to qualify for a 1031 exchange. The first time period is a 45 day window in which the seller must identify replacement properties. The potential properties must be put into writing and delivered to the intermediary. The next time period is a 180 day window in which the “exchange” property must be closed on. The 180 day period is calculated between the closing date of the first property and the closing date of the exchange property. If these time restraints are not strictly complied with then the 1031 exchange will not be complete, and the tax deferments will not apply.

If you are a real estate investor that is interested in pursuing tax deferment through a 1031 exchange, call the experienced Tampa real estate lawyers at DeWitt Law Firm to discuss your options.