Taking Advantage Of The 1031 Exchange
Rule
The 1031 exchange rule is a rule legislated by IRS
(Internal Revenue Services) of US Department of Treasury that
benefits property buyers and sellers. This rule provides for
deferring taxes on the profit made on a property sale subject
to the condition that this sale amount is utilized for another
investment on a similar asset within a stipulated period. There
is no provision for tax avoidance. However, in order to enjoy
such a benefit only if the person follows rules and regulations
specified
in IRS 1031 exchange law. It should be clearly understood
that not all properties can be bought or sold without paying
taxes.
The location of the exchange law in IRS tax rule book has
given this law the name 1031 exchange rule. This law is also
called ""Like-Kind"" law because of specific clause which
indicates that like-kind property only can be exchanged.
Many individuals and companies take advantage of this law to
defer taxes on properties which are costly in nature.
This rule mainly is advantageous for transactions of
properties of higher value e.g. land, buildings, vessels,
planes, cattle etc. People in many cases purchase
a new property by using sale amount from an old property
and this type of transaction amounts to reinvestment. Without
the provision of 1031 exchange if a property is sold at
$100,000 the seller has to pay a tax of $35,000. This will
reduce the reinvestment amount for the seller in case he wants
to reinvest using the sale amount. The exchange law permits the
person to defer the tax of $35,000 indefinitely thereby
allowing him to use the entire amount of $100,000 for
reinvestment.
One of the main requirements for allowing 1031 exchange is
that the properties sold and purchased have to be of similar
type. It is not necessary for them to be of the same type. For
example, sale proceeds of land cannot be used for buying a
ship. However, transactions such as ship vs. plane, land vs.
building etc. are allowed. Although like-value transactions are
preferred they are not absolutely essential. Another constraint
in this type of exchange is the time factor specified by IRS
which is 45 days. The whole transaction has to be completed
within this time period to avail tax deferment. In case it is
not possible the person has to submit to IRS the list of properties in which
he is interested in before 45 days and finalize the deal before
180 days. Otherwise the money will be taxed.
The purpose of 1031 exchange law is to encourage investment
and not for selling for profit. In this exchange, both buyer
and seller do not hold the money. The money is held by a
qualified intermediary who will hand over the amount to the
buyer once the deal is finalized. In case sale value of the
property is $100,000 and the purchase value of the new property
is $80,000 it violates 1031 exchange rule. Since a lot of
legal requirements are to be complied in 1031 exchange it
is advisable that the task is outsourced to a qualified
intermediary company.
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