Understanding Form 1031

2008-10-22 17:20:26

( Financial )



Real Property Investments and Capital Gains Tax

Real estate property can serve as your residence or as an investment. You buy the property at a specific price, hoping that its market value will rise sometime in the future. When the property value rises and you are able to sell it at that level, you gain profits from the sale. Being a form of income, this profit is subject to capital gains tax. Since the amount is calculated at about a quarter of the gains, you stand to pay a huge amount just for the capital gains tax.

You may think that the only way out of paying capital gains tax is if you have sold the home at a price which is equal or less its current value, or if you have to pay off an existing mortgage that only offsets the profit you earned. While these may be so, there is another legal way under IRS tax laws that will exempt you from paying the gains tax - the 1031 tax deferred exchange provision.

The 1031 Tax Deferred Exchange Provision

If you are an investor who buys property now and sells it in the future in order to buy another one, you should take note of this provision and the possible breaks you could enjoy with it.

As its name implies, the provision allows you to defer your capital gains taxes from selling one piece of real property if you immediately buy another piece of property with the sale proceeds. In effect, you have exchanged one property for another in the transaction, and you have reinvested 100% of the sale proceeds from the old property into the new one.

Conditions for Claiming 1031 Tax Deferment

You must have reinvested all of the proceeds you gained from selling one property into the purchase of another. Your name must appear on the title and deeds of sale of both properties to prove your ownership and therefore your entitlement to the tax deferment.

The transaction must be overseen and handled by a qualified intermediary such as an escrow or title company.

Finally, the time gap between the sale of the old property and the purchase of the new one must be 180 days or shorter to qualify as an exchange.

Filling Out Form 1031

The main document for reporting and claiming the exchange of two or more properties is Form 1031. Completing Form 1031 may seem like a very tedious process because it has several required schedules that you need to fill out. You need to sign like-exchange agreement forms, qualified intermediary agreement form, and various disclosure statements.

Fortunately, your intermediary is well-versed in the preparation of documents and requirements for Form 1031. You should work with the intermediary as well as with all other parties involved in the buy and sell transactions to assure expedient handling of the claim.


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