1031 Exchange – What is it and How Does it Work

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A 1031 Exchange may also be called a Like-Kind Exchange or a Starker Exchange. Regardless of the name it’s called by, it’s a tax-deferment strategy successful investors use. It becomes an even bigger factor in real estate investing once a city has surpassed the “bubble levels”.

What is a 1031 Exchange?

Before you start using a 1031 Exchange, it’s necessary to define it. Under section 1031 of the IRS code, a 1031 Exchange is defined as a strategy investors can use to “defer” paying capital gains taxes on a property they own as an investment when that property is sold. The investor can avoid paying these taxes, as long as a like-kind property is purchased with any profits gained from the sale of the other property.

Basically, breaking down what a 1031 exchange is, involves two properties. As an investor, you will have a property you will sell and gain profits from. Then, those profits will be used to buy what is known as a like-kind property. As long as this is done correctly, capital gains taxes can be avoided on the sale of the first property.

What is a Like-Kind Property?

In order to use a 1031 Exchange, a like-kind property must be acquired with the profits from the sale of another investment property. Defining this type of property is vital to using a 1031 exchange as an investor.

The term “like-kind property” is rather broad, but can be simplified. The term basically means the property purchased with the profits from the sale of another must include “the same nature or character, even if they properties different in quality or grade”.

In order for the property purchased to be labeled as a like-kind property, it needs to be similar to the property sold. For example, if the investor is selling an apartment building, they need to buy another apartment building or something similar, such as a duplex or a multi-family property.

The property doesn’t have to be exactly the same; however, as a commercial office building may be allowed when selling a single-family rental home or a vacation rental may be sold to purchase a restaurant space. The one huge exception is both properties need to be located in the United States to qualify for a 1031 exchange.

If used correctly, a 1031 Exchange will allow you, as an investor, to sell a current property to purchase another property without paying capital gains taxes. It’s important to understand what this exchange is and how it works if you plan to invest in real estate.

I would love to be part of your journey when the time is right for you. If you ever have a real estate question or need, or know someone who does, trust that you can turn to me 704-650-5707 | annagrangerhomes@gmail.com.

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