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What is a 1031 Tax-Free Exchange?

On Behalf of | Oct 30, 2023 | Real Estate Law

If you are selling real estate while purchasing other real estate, you might want to consider a 1031 tax-free exchange. This is a like-kind property exchange that allows Florida property owners to avoid paying taxes when purchasing real estate because they are exchanging one property for another like-kind property.

There is no strict definition of a like-kind property, but it generally means a property of the same nature. For example, selling a cabin and purchasing another cabin. 1031 tax-free exchanges cannot usually be used for primary residences, but only for commercial or rental properties.

How it works

With a 1031 tax-free exchange, instead of selling real estate and using the cash you make from the sale to purchase another piece of real estate, the cash goes directly into a third-party escrow company. The escrow company then uses the money to purchase the new real estate.

The biggest benefit to a 1031 tax-free exchange is that it prevents you from paying capital gains tax. You would normally be taxed on the cash you receive from selling your property, but since the cash went to an escrow company instead, you did not receive it. You simply exchanged it for another property.

Rules and requirements

There are important rules to follow to correctly complete a 1031 tax-free exchange. Once you sell your property, you must find a new property to purchase within 45 days and the entire transaction must be completed within 180 days. Failure to meet either of these deadlines could mean you owe capital gains tax.

Additionally, you must never receive any portion of the cash from the sale of your property. This may happen if the property you purchase costs less than the property you sold. You might be taxed on the extra amount of cash you received.

The same goes for mortgages on the properties. If the mortgage on the property you purchase is lower than the mortgage on the property you sold, the difference is typically treated as taxable income.

Help is available

Each step of the 1031 tax-free exchange process must be completed correctly and within applicable deadlines to be successful. You may consider having someone guide you through the process.