Can A 1031 Tax Exchange Save You Money?

For many, tax season has come and gone, yet if you’re a business owner or investor you may have extended your filing and/or information reporting to later in the year. The process for reporting any type of income (especially capital gains) can be daunting, but understanding your forms and the various IRS codes is the first step to saving money. For investments, it begins with Section 1031 tax exchange.

Section 1031 is an IRS code where the tax payment on the gains from the sale of a business or an investment property is deferred should you place that income back into something similar—called a “like-kind” exchange. Here, you’re reinvesting your capital gains, so the taxes are deferred. There is also a use of 1031 where a property exchange isn’t completely “like-kind,” as other non-like-kind properties are included along with cash and forms of debt relief.

With Section 1031 you can save on taxes, as the payment on the gains for that particular tax year is then deferred, but don’t mistake it for tax-free, rather it’s “tax-deferred.” However, there are some regulations within the 1031 exchange and qualifications that must be met for eligibility. Per the IRS site, investment owners and business property owners may qualify, broken down as the following:

• Individuals
• C corporations
• S corporations
• Partnerships (general or limited)
• Limited Liability Companies (LLC)
• Trusts
• Any other taxpaying entities

Much like the title suggests, a 1031 exchange is the “exchange” of property. This can be a simple swap of properties or a deferred exchange where you receive your capital gains and use that income to purchase either one or many like-kind properties as a replacement for the initial one you sold. The latter is far more complex to accomplish, with more rigid tax regulations. The third, a reverse exchange, provides a 180-day time frame where a replacement property is acquired from an Exchange Accommodation Titleholder (EAT).

The biggest piece of information to understand is that the like-kind property in a 1031 exchange must be a trade or business investment, not personal. While personal and real property can qualify within a 1031 exchange, they are not categorized as like-kind. Meaning, a personal property cannot be simultaneously swapped with real property, as they are not like-kind properties. It’s confusing at first, but think of it like this: imagine property as fruit. Like-Kind would be swapping apples for apples, even if one is a Granny Smith and the other Yellow Delicious. However, you couldn’t swap an apple for a pear. Make sense?

To report a 1031 exchange, simply complete the IRS Form 8824 and file it within the same tax year as the year of the exchange. Property descriptions, dates of sale, the value of the properties, gains/losses are among the information requested. Should you have any questions, contact your accountant or the IRS. It’s never advised to venture into a 1031 blindly, as scams and misfiled information can leave you paying taxes and penalties. For more information, visit the IRS site here: https://www.irs.gov/uac/like-kind-exchanges-under-irc-code-section-1031.