The Definition of 1031 Exchange
1031 Exchange is also known as a starker exchange. It is allows people to invest in properties by deferring paying capital gains taxes on the property. An investor is capable of acquiring a property without incurring tax liability through the use of 1031 exchange.
The delayed tax burden makes it possible for an investor to acquire a low-income property that needs high maintenance. The burden of tax is removed when an investor uses 1031 exchange especially when moving investments from one location to another.
The properties that could be swapped through the use of 1031 exchange must be of the same kind and value. However it could be challenging to find another property of the same kind to swap with, for this reason, many of the exchanges takes long or get delayed.
Every time you nee to sell an investment property you are required to pay capital gains tax. To sell an investment property you could incur a lot due to the tax burden. BY using the 1031 exchange you make a kill when selling a rental property that has more value than the time you acquired it.
You could only swap a property of the same kind and value when using the 1031 exchange. The 1031 exchange allows you as an investor to buy time for paying the tax.
1031 exchange does not mean that an investor will avoid paying tax. Before an investor pays the tax, they stay for quite some time when they swap properties. The sudden tax obligation is avoided through the use of 1031 exchange. The main beneficiaries of 1031 exchange are the real estate investors.
Both the purchase price and the loan amount are required to be the same or a bit higher than the replacement property according to the terms and conditions of the 1031 exchange.
There are four categories of the 1031 exchange which includes the simultaneous exchange, delayed exchange, reverse exchange and the construction or improvement exchange.
The simultaneous exchange allows for a direct swap of properties; the exchange happens in one day. Due to the difficulty in finding a person with the same kind of property the simultaneous exchange is not that common. Finding another property of the same kind or exchange is very difficult.
Delayed exchange is the most common type of 1031 exchange. The delayed exchange allows investors to sell properties while they wait for the property of the same kind to be found.
The reverse exchange requires that an investor pays all the money which may be hard to come by since the banks do not lend the money for this particular type of exchange.
Construction or improvement exchange allows an investor to use the remaining funds (in case the property an investor want to buy is less costly than the one they relinquish) to build or enhance the property they want to buy.