What is a 1031 exchange?

On Behalf of | Mar 3, 2021 | Real Estate Transactions

As you look for investment options in New York to grow your personal wealth, real estate often jumps out as an attractive option. Flipping or leasing a property can generate both significant short- and long-term financial gains. Yet as you know from any previous real estate transactions you participated in, the buying and selling processes can be extremely complex.

Not only are they complex, but they also can be extremely costly (especially in terms of taxes on whatever gains come from the transaction). However, a 1031 exchange offers you the potential to delay the payment of taxes on those gains in order to take full advantage of the profit you make on a sale in the here-and-now.

Deferring tax payments on investment gains

According to the Internal Revenue Service, a 1031 exchange allows you to defer the payment of taxes on investment gains if you reinvest those gains in like-kind properties. The key to focus on here is the term “like-kind,” which limits the type of real property you can re-invest in. The property purchased must have a similar nature and character to the property who sale financed it. For example, you cannot defer tax payments on a vacation home you buy from profits made from the sale of rental units (even if you plan on making the property occasionally available for lease).

Vacant land that you buy from investment proceeds that you then build an investment property on qualifies as like-kind. However, real property purchased outside of the U.S. from the proceeds of property sold within it does not.

Handling a 1031 exchange

To property report a 1031 exchange, you must submit a form 8824 detailing the exchange with your tax return in the same year it occurs. If not, you could open yourself up to penalties (on top of the taxes owed on your investment gain).