You can increase your buying power since federal capital gains taxes are deferred, allowing you to leverage these savings by putting them into the new property you are purchasing. This additional equity reinvested in the new property will make your financing easier.
You can do exchange after exchange, each time pyramiding your savings. Additionally, at death, if you choose to pass the property onto your heirs, the deferred capital gains tax liability can be erased by the IRS resulting in a greater profit for your heirs when the property is eventually sold.
As the Exchanger you will have greater selling power since you do not have to inflate the sales price in order to recoup some of the capital gains that would normally accrue when selling an investment property. This will enable you to set a more flexible and potentially profitable price.
You can acquire replacement property with greater income potential, for instance by selling raw land and acquiring income-producing property. You could also acquire an apartment building with additional units or another income producing property in a more profitable location.
You have the opportunity to consolidate several difficult to manage properties into one easy to manage large property or to relocate or expand a current business or investment.
1. Both properties must be "like-kind."
Like-kind simply means real property and refers to the nature or character of the property, not its grade or quality.
Like-kind is a very broad and liberal category where just about any type of investment or business use property would qualify.
Examples of like-kind properties:
- rental properties (single family homes, apartment buildings, triplexes, etc.)
- office buildings, shopping malls, almost any type businesses, airports, marinas, golf courses, etc with a lease of at least 30 years including options
- parking lots
- factories, retail stores
- interest in a co-tenancy
- oil, gas and mineral interests
- timber and water rights
It is important to note that the properties not considered as like kind include: stocks, bonds, notes, interest in a partnership, certificates of trust and personal property.
Properties can be located anywhere within the US with no restrictions relating to the exchange taking place in one or more states.
2. Both properties must be held for investment or business use.
Both the relinquished property and replacement property must be for investment or business use and each must be held for a minimum of one to two years.
You cannot purchase a replacement property with the intent to sell immediately.
Qualified 1031 exchange properties cannot be used for personal use more than 14 days per year (or 10% of the actual number of days the property has been rented in any given year).
3. Exchanger must use a qualified intermediary.
One of the so called "safe harbors" in the 1031 Exchange regulations is the requirement to use Qualified Intermediary in the actual exchange process.
Both the sale of the property you sell and the purchase of the replacement property must flow through the Qualified Intermediary, usually by direct deeding to avoid duplicate transfer taxes.
The Qualified Intermediary may not be the taxpayer or an agent of the taxpayer (realtor, attorney, tax advisor, banker, accountant, employee, etc.) or lineal descendant of the Exchanger.
4. Seller must use a qualified escrow agent.
The qualified Escrow Agent may not be the taxpayer (seller) or an agent of the taxpayer (such as your realtor, attorney, banker, accountant or other employee, etc.) or an actual lineal descendant of the Seller.
The Seller should not have any type of access to the proceeds from the sale of the property.
The Seller is entitled to all earnings on the escrow funds, but these taxable funds must also be restricted in the same manner as the principal.
The Seller is entitled to obtain security for his funds while the 1031 transaction is in progress.
5. To gain the benefits of a 1031 tax exchange the proper documentation must be used.
1031 Investment property exchange - Mega 1031 has the highest level of account security, expertise and service in the industry.