Frugal Francis

The 1031 exchange program is a program that allows a real estate investor or property owner to defer paying capital gains tax by reinvesting all proceeds from the previous sale of the relinquished investment property into a replacement property of like-kind or greater value. This tax-deferred exchange takes its name from Section 1031 of the Internal Revenue Code.

For savvy real estate investors, the 1031 exchange program is regarded a wise strategy to reduce taxes. It is indeed popular among real estate investors since it allows more flexibility in their real estate investments. They are also able to retain as much capital as possible. The 1031 exchange program allows real estate investors to maximize the liquidity of their investments by selling properties when they have attained the maximum ROI without needing to wait to choose another property to buy in which they have additional ownership and management responsibilities.

Capital gains tax can be such a big tax bite that can significantly affect funds available for future real estate investments. The 1031 exchange option has become a successful estate planning tool for many real estate gurus.

Prior to 1984 legislation on the 1031 exchange, there were no time constraints applied on the exchange. There were many difficulties encountered when trying to select suitable replacement properties as well as in the transfer of titles and funds. The 1984 Section 1031(a) that Congress passed addressed such problems.

The Internal Revenue Service imposes strict requirements for real estate investors to avail of the 1031 exchange program and legally defer paying capital gains taxes.

The real estate investor must reinvest 100% of the proceeds from the previous sale of the investment property into a new replacement property that should be of like kind or greater value. This is one of the main qualifications for the 1031 exchange option.

Real estate property held for investment or business use qualifies for the exchange. The relinquished property and the replacement property should both be held for a productive purpose in a trade or a business. They should be like-kind properties.

There are also time requirements an investor must adhere to. The investor is required to identify three potential replacement properties within 45 days from the closing and transfer of the original investment property. The investor must also close on the exchange property within 180 days of this date. Deadlines are absolute and there are no exceptions. The time period includes weekends as well as holidays. If the investor is not able to comply with these deadlines, the 1031 option becomes unavailable.

The IRS mandates that real estate investors find a Qualified Intermediary (QI) to conduct the 1031 exchange transaction. The Qualified Intermediary must be an independent party. An investor’s accountant, broker, attorney or employee may not conduct the transaction.

These are the essential requirements of the 1031 exchange program. Its process and completion may become complex and it would be best to consult with a tax specialist or accountant regarding all of the tax implications and requirements of the 1031 exchange program.

How can you make your money grow? To learn tips on saving, earning and investing money, visit Frugal Francis on a regular basis. http://www.frugalfrancis.com/ .

Frugal Francis is a personal financial advice and money management site that is dedicated to my money-smart father whom my sisters and I fondly call Frugal Francis.

Growing up, I learned a lot of practical financial advice from my father. I have formed money-saving habits that have helped me throughout my life. My father was indeed right to teach us how to “Spend less, Earn more and Save as much as possible.”

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Sources:
http://homebuying.about.com/od/realestateglossaryl/g/like_kind.htm
http://homebuying.about.com/od/investmentproperties/a/102008_1031Exch.htm
http://www.ehow.com/way_5412087_exchange-options.html
http://www.clearleadinc.com/site/1031-exchange-option.html