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Using IRC 1031 Tax Law to Exchange Investment Property Tax Free

Avoiding Income Taxation through Tax Law IRC 1031

Current tax law provides that individuals selling investment or business real estate at a profit are subject to income taxation.

The tax rates on profits under the tax law code are:

  • 15% Federal capital gain
  • 25% Depreciation recapture
  • 9.6% California capital gain (other states vary)

We have saved clients thousands of dollars in our tax law practice by helping people utilize tax law IRC 1031 (“tax deferred exchange”) to reinvest the profit from the sale of the investment or business real property in future real property acquisitions.

If the tax deferred exchange is handled properly under the tax law, buyers and sellers of investment property can “roll” the proceeds over into another investment of equal or greater value “tax free.”

IRC 1031 (“Exchange”) Tax Law Guidelines

 

There are five guidelines under tax law IRC 1031:

  • Investment Property: The property being sold and property being acquired must be “investment” propertyunder the tax law rules.
  • Qualified Intermediary: A “qualified intermediary” (third party that is not the agent of buyer or seller) must hold the proceeds from the disposition of the investment property before the acquisition property is purchased. Use of a qualified intermediary allows the buyer and seller todispose and acquire their investment property at different times (“non-simultaneous exchange”).
    • Hanleylaw established a qualified intermediary, Fidelity Exchange, Inc., in 1986.
    • We’ve successfully assisted hundreds of individual and business clientele to use IRC 1031 tax law to exchange commercial, agricultural, and residential real property without adverse IRS audit.
  • Designation of Acquisition Property w/in 45 days:  The acquisition property needs to be designated (usually by street address) within forty-five days from close of escrow on the prior investment property.
  • Close on New Investment w/in 180 days:  Close of escrow on the new investment property need to occur within 180 days from the sale of the prior investment property.
  • Property Valuation: The property acquired must be equal to or greater in value than prior investment property.
  • What’s the catch to this “tax free” tax law?  A 1031 is not truly tax free as the tax law provides that the old tax basis is transferred over to the new purchased investment.
  • Example: Your prior investment has a basis of $100,00 (purchase price less depreciation) and a current value of $750,000. You use IRC 1031 tax law to exchange for a new investment property of $750,00. Your tax basis in the new property is $100,000 (not the purchase price of $750,000). Subsequent sale of the investment property without use of tax law IRC 1031 subjects you to capital gain.

IRC 1031 tax law places no limits on how many times it can be used.  Proper planning and use of 1031 tax law allows you to create wealth in real estate as equity can be transferred to new property without capital gain.

About Sean Hanley

Practicing law since 2007, Sean specializes in the ever-changing laws related to real estate, business and estate planning. Embracing technology with a focus on personalized service, he understands the challenges of living and thriving in Silicon Valley. Tapping into his education in economics and business administration, Sean also serves on the non-profit Willow Glen Business Association.

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