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Simple English definitions for legal terms
1031 exchange
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A quick definition of 1031 exchange:
A 1031 exchange is when someone sells an investment property and uses the money to buy a similar property instead of keeping the money. This allows them to defer paying taxes on the profit they made until they sell the new property. They have to buy the new property within 45 days and it has to cost the same or more than the original property. They can buy multiple properties to fulfill this requirement. The taxes they eventually pay will be based on the changes from the exchange.
A more thorough explanation:
A 1031 exchange, also known as a tax-deferred exchange, is a process that allows investors and organizations to replace one investment with a similar one instead of keeping the proceeds. This exchange enables the investor or organization to defer capital gains taxes until the new investment is sold for the proceeds.
For example, let's say an investor sells a rental property for $500,000 and wants to purchase a new rental property for $600,000. Instead of paying capital gains taxes on the $500,000, the investor can use the money to purchase the new property and defer the taxes until the new property is sold.
Section 1031 of the Federal tax code governs 1031 exchanges. It requires the investor or organization to select a new investment within 45 days and complete the purchase within 135 days after identification. The new property must cost the same amount or more than the original property, and they can acquire multiple similar investments to fulfill this requirement.
The basis for the original investment will be adjusted to reflect the changes from the exchange of property so that the final capital gains taxes will accurately reflect what gain or loss the investor incurred.