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Table of Contents:
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What Is A
1031 Exchange?
Let’s start with the basics: what is a 1031 exchange?
A 1031 exchange is named after the Internal Revenue Code Section that defines its rules and regulations (much like a 401(k) or 403(b) account). It helps real estate investors achieve one of the holy grails of investing: deferring capital gains taxes when selling an investment property by reinvesting the proceeds into a subsequent, similar investment property.
Done correctly, the second real estate purchase assumes the cost basis of the original purchase, and capital gains taxes are deferred until the ultimate sale of the newly acquired real property. Of course, when it’s time to sell the second property, another 1031 exchange can be executed, so the business of paying taxes on your sales can, in theory, be deferred indefinitely. It’s not unheard of for savvy real estate investors to defer capital gains taxes for decades by stringing together a number of 1031 exchanges, year after year. Many professional real estate investors even use 1031 exchanges as a central component in their estate planning.
Sound simple?
Not so fast.
Potential Pitfalls
of a 1031 Exchange
While the potential benefits of a 1031 exchange are compelling enough to encourage any real estate investor to consider them, there are many potential pitfalls to a 1031 exchange.
These can involve:
These are only some of the areas in which an unaware real estate investor may run afoul of Section 1031, and any one of these critical errors could be enough to render the exchange ineligible for the valuable benefits offered by the IRS, even if all of the other rules are followed to the letter.
In the field of 1031 exchanges, such pros are known as qualified intermediaries, exchange facilitators, or exchange accommodation titleholders, and their importance to a successful, IRS-compliant transaction cannot be overstated.
Know and Understand
The Rules of a 1031 Exchange
What is true of most real estate investments is doubly true of the 1031 exchange: it is critical to know and understand the rules surrounding these transactions, and essential for even the most experienced real estate investors to enlist professional help in following them all. In the field of 1031 exchanges, such pros are known as qualified intermediaries, exchange facilitators, or exchange accommodation titleholders, and their importance to a successful, IRS-compliant transaction cannot be overstated.
The common factor across these diverse factors is the deferral of capital gains taxes.
Reasons Why An Investor
May Consider A 1031 Exchange
There are many different reasons why an investor may consider using a 1031 exchange, such as:
That’s why I’ll be addressing every critical aspect of 1031 exchanges in this Guide to A 1031 Exchange, not only to encourage investors to consider these exchanges carefully in lieu of paying a potentially exorbitant and possibly avoidable capital gains tax, but to educate investors about the process so that they are able to take full advantage of something that the IRS rarely offers (and never offers without strings attached): a valuable tax break!
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