If you own real estate that will provide you with a profit on the sale, you should consider whether a 1031 exchange is right for you. There are five different classes of property taxes: property used in the taxpayer’s trade or business, property held for the purpose of selling to customers, property used as a principal residence, property used as a vacation home and property held for investment. .
The 1031 exchanges apply to both property held in a taxpayer’s trade or business as well as property held for investment and, in certain situations, property held as a vacation home. Please note the following stipulations:
• Property held for immediate sale is not considered an investment.
• Commercial use can be defined as the ownership of property for productive use in business or commerce.
• Property that is removed from prior “productive use” in the business may qualify
There are many potential benefits to using a 1031 exchange, as long as you are clear on how best to maximize your advantages. Examples of benefits include:
• Own multiple buildings instead of just one
• Gain leverage
• Defer payment of capital gains taxes
• Relocate to a new area
• Consolidation or improvement of buildings
• Obtaining relief from property management
The real property you sell, as well as the real property you buy, must be put to a productive use in a trade or business or for investment purposes, and must be similar. To obtain tax benefits, the proceeds of the sale must pass through a qualified intermediary and not through your own hands, even briefly. If funds pass through your hands at any time, any and all cash income you earn may be taxable.
There are many different types of properties that can be traded in this way. “Similar type” refers to properties that are similar in character or nature. Examples of popular similar properties may include commercial properties, condominiums, vacant lots, rental houses, duplexes, or apartments. Properties that are not of the same type are primary residences, notes, partnership shares, stocks and bonds, properties for immediate resale, or developed lots held for sale purposes.
You should never try to handle the funds associated with a 1031 exchange on your own. Doing so can eradicate your capital gains tax deferral and make you pay taxes, eliminating one of the main reasons people seek 1031 exchanges in the first place.