Many of our clients who regularly invest in real estate often use 1031 exchanges in order to defer their tax liability on investment properties by using the sales proceeds from the sale of one investment property to purchase a new investment property. Section 1031 of the IRS code contains the basic concept that if the investor didn’t personally receive the proceeds from the sale but instead had those proceeeds held by a qualifed exchange facilitator then there isn’t any income to tax.
1031 exchanges are a common tax code application used by investors who want to upgrade to a larger more expensive investment property without paying taxes while selling their smaller less expensive property. It is also used by investors who wants to sell a property located in one market and buy a property located elsewhere.
WHAT ARE THE REQUIREMENTS TO QUALIFY FOR A 1031 EXCHANGE?
When completing a 1031 exchange you must adhere to a strict timeline in order to qualify for the tax deferment. Specifically, there are two important time limits you need to keep in mind:
First you will have 45 days from the sale of your original property to identify potential replacement properties. You can identify as many as three like-kind properties to buy, or as many as you want if the combined value doesn’t exceed 200% of the sale price of your original property. These properties must be identified in a written document and clearly described with the properties’ street addresses or legal descriptions, and this document must be delivered to your exchange facilitator (An exchange facilitator is the 3rd party who holds your sales proceeds per the 1031 code requirements).
Second you'll have 180 days from the sale of the original property to close on the purchase of your replacement property or properties. This is when the entire exchange process needs to be completed. FYI, these timeframes refer to calendar days, not business days. And if there is more than one property involved in your 1031 exchange, the clock starts when the first property is sold.
HOW LONG CAN I DEFER PAYING THESE TAXES?
The short answer is FOREVER. As IRS Code 1031 is currently interpreted the taxes can be deferred indefinitely as long as no monetary benefit is ever persoanlly received by the seller(s) from the sale of a property. For example, if you sell property # 1 usings a 1031 exchange, then buy property # 2 and hold it for several years and then sell property # 2 and buy property # 3 again using a 1031 exchange you can continue to avoid paying certain capital gains taxes. So long as you never "cash out" you can defer these taxes forever. As with all tax issue we advise our clients to confer with their accountant on these matters relating to their tax liability.
For more than 35 years, the legal team at O’Sullivan & Zacchea has represented clients in a wide range of residential and commercial real estate transactions for individuals, investors and companies in New York City and its surrounding counties. We are well versed with what is required to successfully complete a 1031 exchange and the special terms and conditions that must be part of these real estate transactions. If you have any questions about the 1031 exchange process or if you want to retain an attorney to represent you in the purchase or sale of real estate please feel free to call Kevin O'Sullivan at (718) 713-3499 or e-mail him at kosullivan@ozatlaw.com for a free consultation, Prior to co-founding the firm Mr. O'Sullivan was an attorney with the New York City Department of Buildings.