Understanding Section 1031 Tax-deferred Exchange

Every individual who wishes to take full advantage of the benefits of Section 1031 Exchange must understand that each transaction is different. Although there are rules and procedures that apply to everyone in general, successfully accomplishing one's investment objectives entails exercising due diligence and consulting the right professionals for some much needed legal and fiscal advice.

Unlike regular transactions where a property owner is taxed on gains earned from sales, tax on a Section 1031 Exchange gain is deferred. This is possible because the Internal Revenue Code's Section 1031 states that an exchange of property that is held for trade, business, or investment purposes recognizes neither gains nor losses. Theoretically, a taxpayer's investment did not change in any other way other than its form, so it would only be fair for him or her not to be obligated to pay tax.

This should not mean, however, that a Section 1031 exchange is tax-free. It is only tax-deferred and when the time comes for the replacement property to be sold, the gain from the original transaction, in addition to any other gain realized since the replacement property was purchased, will be subjected to tax just like every other form of transaction.

Navigating the 1031 Exchange Minefield

Doing a Section 1031 exchange transaction may be one way to help process your property as you swap it for another. This is especially true when you're dealing in real estate or other large tangible assets. However, doing a 1031 carries a lot of potential dangers, to the point that it can blow your finances out of the water if you're not careful. Here are some tips to avoid that.

As 1031 exchanges mostly deal on like-kind property, this is often misinterpreted as a tit-for-tat thing; some experts say that like-kind property deals with its intended purpose instead of type, such as a rental house for a tract of land. It is important for a taxpayer to familiarize with all of the key regulations during the structuring of the exchange.

If you've relinquished your property, you only have 45 days to find a replacement property, but do not wait until the last few days to start looking. Time is of the essence because you cannot mark a replacement property when the window has closed. If you do decide to sell a property and closed the deal, forget about a sudden change of plans to do a 1031 exchange.

These are only a few dangers you can prevent at the early stage of a 1031 exchange. A credible 1031 specialist can help you get all your bases covered.