Tax Advantages of a Section 1031 Exchange

February 8, 2023
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It’s no secret that Section 1031 exchanges offer a great wealth-building solution for real estate investors. It allows you to make a like-kind exchange of properties with tax-deferred advantages.

Tax Advantages of 1031 Exchanges

You will be able to avoid taxes on all property upgrades during your lifetime. Your heirs can then receive the property with a step-up to fair market value. In most cases, they’ll be able to sell the property without paying any capital gains taxes.

However, there are some real estate owners looking to get away from holding properties. The good news is there are other tax-advantaged strategies you can consider:

We are going to focus on the Delaware statutory trust in next week’s article. But first, it helps to have a better understanding of how 1031 exchanges work. The purpose of tax code Section 1031 is simple. You are allowed to swap a business asset without there being a taxable event. You are exchanging it for a like-kind property, which means your economic position isn’t really changing and capital gains taxes wouldn’t apply.

1031 Exchange Qualification

Before you sell the old asset, you must begin the 1031 exchange by contracting with a qualified intermediary. You may list up to three potential replacement assets within 45 days of the sale. Then, you must close on at least one of those new assets within 180 days of the sale. For the exchange to be completely tax-free, the new asset must be of greater value than the one you are selling. If you aren’t trading up, you will likely have some taxable gain.

IRC Section 1031(a) states that “no gain or loss is recognized on the exchange of real property held for productive use in a trade or business or for investment (relinquished real property) if the relinquished real property is exchanged solely for real property of a like kind that is to be held either for product use in a trade or business or for investment (replacement real property).”

Qualified and Non-Qualified 1031 Assets

Qualified Section 1031 assets include (but are not limited to):

  • Residential or commercial real estate held for investment, rental or business use
  • Raw land held for investment
  • Tenant-in-common held real estate
  • Delaware statutory trust interests

Non-qualified Section 1031 assets include:

  • Securities, stocks and bonds
  • Partnership interests
  • Assets held as inventory
  • Personal-use real estate
  • Foreign real estate

To learn more about Section 1031 exchanges and other tax-advantaged selling/trading strategies for business owners and real estate investors, contact Illumination Wealth today.