How can I defer capital gains taxes using a 1031 exchange?

Steps to Defer Capital Gains Taxes Through a 1031 Exchange

1. Determine Eligibility

- Ensure that the real estate property you intend to exchange is held for business or investment purposes and not primarily for sale.

- Confirm that both the relinquished property and the replacement property are of like-kind, which means they are of the same nature or character, even if they differ in grade or quality. Real property in the United States is not like-kind to real property outside the United States.

2. Plan the Timing

- Initiate the 1031 exchange process before you sell the relinquished property. The exchange must be set up with a Qualified Intermediary (QI) before the sale closes.

3. Engage a Qualified Intermediary

- Select a QI to facilitate the exchange. The QI will hold the proceeds from the sale of the relinquished property and use them to acquire the replacement property.

4. Sell the Relinquished Property

- Complete the sale of your relinquished property. The proceeds from the sale must be transferred to the QI to avoid constructive receipt and disqualification of the exchange.

5. Identify Replacement Property

- Identify potential replacement properties within 45 days of the sale of the relinquished property. You can identify up to three properties without regard to their market value (Three Property Rule), or more if they adhere to certain valuation tests.

6. Complete the Purchase of Replacement Property

- Close on the replacement property within 180 days of the sale of the relinquished property or the due date of the income tax return (including extensions) for the tax year in which the relinquished property was sold, whichever is earlier.

7. Report the Exchange

- Use IRS Form 8824, "Like-Kind Exchanges," to report the details of the exchange to the IRS, including the properties exchanged, dates of transactions, and financial aspects. For more information on how to complete Form 8824, refer to the [Instructions for Form 8824].

8. File Tax Returns

- Include Form 8824 with your annual tax return for the year in which the exchange occurred.

Additional Considerations

- If you receive cash or other non-like-kind property in addition to the replacement property, you must recognize gain to the extent of the other property and money received.

- Real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind” can qualify for a 1031 exchange under the Internal Revenue Code Section 1031. Personal or intangible property does not qualify for a like-kind exchange under current tax law.

For further details on like-kind exchanges and the specific requirements, you can refer to the [Like-Kind Exchanges - Real Estate Tax Tips] on the IRS website.

Note: This guidance is based on the information provided and current as of the latest IRS publications. Always ensure you are using the most recent forms and instructions from the IRS when conducting a 1031 exchange.

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Sources:

Like-Kind Exchanges - Real Estate Tax Tips | Internal Revenue Service 2024-08-03

Instructions for Form 8824 (2023), 23 Internal Revenue Service Department of the Treasury 2024-08-02

Opportunity Zones Frequently Asked Questions | Internal Revenue Service 2024-08-04

Publication 544 (2023), Sales and Other Dispositions of Assets 2024-07-30

Publication 523 (2023), Your Home Page 1 of 25 12:30 - 7-Feb-2024 | Internal Revenue Service 2024-07-30

Publication 523 (2023), Selling Your Home | Internal Revenue Service 2024-08-04

2023 Instructions for Schedule D (2023) | Internal Revenue Service 2024-08-03

Publication 537 (2023), Installment Sales | Internal Revenue Service 2024-07-30

General Instructions 23 | Internal Revenue Service 2024-07-31