If a person sells off a piece of investment property and realizes a financial gain, the property seller often pays tax on the gain at the time of the sale. For people who then use the amount of the sale to purchase another investment property, they will be required to pay taxes a second time. Tax code section 1031, however, allows people to realize a tax deferred exchange of properties, which means that substantial tax amounts can be saved. Because this area of law is particularly complicated, people who purchase real estate often find the assistance of a real estate attorney helpful to make sure they properly realize the benefits of section 1031.
While Section 1031 lets property investors defer the payment of capital gains tax through the acquisition of replacement property, there are some specific requirements that must be satisfied for an investor to use this section of tax code. To help provide a better understanding of Section 1031, this will review the important requirements of this section of tax code.
A Qualified Intermediary Must be Appointed
Sometimes called an “exchange facilitator,” a qualified intermediary must be assigned to the purchase and sale agreements or contracts before the property transaction closes, and the sales proceeds must be placed with the qualified intermediary between the sale of the relinquished property and the purchase of the replacement property. If a qualified intermediary is not appointed, a transaction will not qualify for Section 1031. This intermediary will make sure that the transaction is correctly structured.
The Replacement Property Must Meet Certain Criteria
A person must select a certain type of property to qualify as a replacement under Section 1031.
First, the replacement property must be equal or greater in net purchase value than the net sales value of the property sold, or the difference will be considered “boot” and this difference will be subject to capital gains treatment.
Second, all proceeds, as well as debt from property #1, must be invested and replaced by property #2. It should be noted that an investor can either sell multiple properties exchanging for a single property or sell a single property exchanging for multiple properties.
Third, the property must have a qualifying use, which means that it must be held as an investment or rental property or used for business or trade conducted by the property owner.
Property transactions in accordance with section 1031 must follow several important rules. An investor has 45 days from the close of property #1 to determine which potential replacement properties exist and properly identify those replacement properties. Investors are allowed to identify up to three potential replacement properties, which provide alternatives in case the purchase of one of the desired replacement properties encounters obstacles, or multiple replacement properties as long as the fair market value of these do not exceed 200% of the value of the relinquished property. The property owner has 180 days in which to complete the exchange.
Contact a Knowledgeable North Dakota Real Estate Law Attorney
Section 1031 is just one of many complicated property laws that can potentially provide significant financial benefits for sellers. If you are interested in taking advantage of a Section 1031 exchange, contact experienced real estate attorney Dean Rindy online at O’Keeffe O’Brien Lyson Foss today or call him at 701-235-8000 or 877-235-8002.