A 1031 Exchange, named after the IRS code, allows you to sell investment real estate and replace it with other investment real estate without creating a taxable event.
Many investors don’t realize that taxation on the sale of investment property does not have the same tax advantages enjoyed when selling their principal residence. Profits are often substantially affected by tax consequences. With a 1031 Exchange, you can defer payment of the tax normally due on the sale of your property that has a taxable gain.
There are many benefits to performing an exchange instead of a sale and new purchase. It can make more funds available for the new purchase by deferring any tax payments that would have been due. It can also help you with your investment income. By allowing you to sell investment properties that aren’t giving enough return and use the non-taxed gain to purchase another property that produces more cash flow, you can greatly increase your income.
To qualify for a 1031 Exchange, you must trade real estate that is held for business or investment purposes for other like investment property. 1031 Exchanges can not be used in the sale of your primary residence or second home.
To qualify, you must use a Qualified Intermediary, who in turn buys the next property you have chosen. You are not required to exchange all of your cash from the sale of the first property into the purchase of the second. However, if you take proceeds from the first sale, each dollar taken is subject to capital gains tax. To avoid the tax, you must rollover the entire gain into the new property. You may also exchange one property for several others or vice versa. It does not have to be one for one.