Several weeks ago, a couple from New Orleans notified me that they had closed on the sale of their rental property on the Gulf coast, and that they desired to do a 1031 tax-deferred exchange and invest the proceeds of that sale into rental property in the Highlands area.
I completely understood that they were weary of weathering hurricane seasons, as well as why they wanted to shift their investment from the beach to the mountains. They were wise to leverage the power of a tax-deferred exchange for their investment.
A tax-deferred exchange allows an individual to sell income, investment or business property and replace it with a like-kind property. Such an exchange can be a powerful wealth-building tool, as capital gains on the sale of this property are deferred or postponed as long as the IRS rules are meticulously followed.
According to the IRS guidelines, the two major rules to follow are:
1. The total purchase price of the replacement “like kind” property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.
2. All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, “like kind” property.
Timelines are most important in tax-deferred exchanges, and there are two key time periods for the investor: the identification period and the exchange period.
The identification period is the crucial period during which the party selling a property must identify other replacement property that she or he wishes to buy (which may be more than one property). This period is scheduled as exactly 45 days from the day of selling the relinquished property.
The exchange period is the period within which a person who has sold the relinquished property must receive the replacement property. The Buyer has exactly 180 days after the date on which he or she closed on the relinquished property to complete the transaction.
By utilizing a 1031 exchange, Buyers are able to maximize their investment potential. As they may use the entire amount of the equity from the exchange, they may acquire substantially more replacement property. Properly structured and administered, an exchange becomes an invaluable tax-saving tool and an integral element of savvy real estate investing.
Further, the tax-deferred exchange proves to be an excellent vehicle for property owners looking to make an investment transition of ownership of real property located in one part of the country to ownership in another area (as in this case, from coastal property ownership to investing in Highlands, NC real estate).