Is there anyone who doesn’t want a free ride from the IRS? Most people spend a lot of time trying to understand the tax rules and figure out how to make the most desirable outcome for themselves financially. It isn’t uncommon to see individuals who leave their entire tax scenario up for debate each year. Unfortunately, these people don’t realize that there is an easy way to achieve a free ride from the IRS using a Section 1031 Tax-Deferred Exchange.
Using this handy maneuver, you can essentially get rid of one of your properties without incurring capital gains taxes. Because you did not incur the capital gains tax liability, you now have the ability to let your deferred taxes go to work on your behalf instead of the federal government. You are receiving what equates to an interest-free loan straight from the IRS.
You might be wondering whether you can qualify for this free ride from the IRS. The requirements are a little involved, and it’s important to ensure that you understand them completely before proceeding with this endeavor.
First, you should know that the general definition of an exchange doesn’t necessarily mean that you are immediately trading one property for another. You may sometimes sell one property and hold off while you search for the perfect replacement. The IRS typically grants a 180-day window for property owners to shop for a replacement home. This entire process is known as a delayed exchange.
In order to qualify for the benefits of the exchange, you must meet four criteria:
The property must be used for business or investment
Both of the properties in the exchange must be used as investment properties or business centers, even if they are not exactly the same. They might be exchanged for a property that is exactly the same (such as two rental houses) or for something different (a rental home versus a commercial building). They cannot be your primary residence or a property you are holding simply to sell.
You have a 45-day identification period
From the date you close on the first property, you have 45 days to identify a proper replacement property that is identified in a letter signed by the exchanger and received by the intermediary. There are multiple ways to identify properties including the three-property rule and the 200% rule. Under certain circumstances, both of these rules may be broken as well.
You have 180 days to close on the new property
From the date of your closing, you have 180 days to purchase a new property. However, the closing on the new property must take place at a minimum by April 15th. Otherwise, you have to file an extension on your taxes with the IRS.
Delayed exchanges must work with an intermediary
If you choose to delay purchasing a new property, you must work with an IRS approved intermediary. This person is responsible for handling all of your paperwork in structuring the sale of your properties.
The good news is that you may never have to pay capital gains taxes if you are always doing an exchange. This could allow you to continue purchasing properties for years to come. Unless you’re selling them for profit, this Section 1031 Tax-Deferred Exchange is a great way to get a free ride from the IRS. Allow Pyramis Company and our commercial property management team to help you manage your investments wisely.