In 1921, 1031 tax-deferred exchanges were introduced as part of the USA’s tax law. Years later, a large number of misconceptions still surrounds it even though tax-deferred exchanges are prevalent in real estate today.
While this system was introduced to encourage tax savings, the deeply rooted misconceptions often end up derailing an exchange, or limiting the tax that could have been deferred.
The only way to steer clear of the pitfalls is to learn all about it. For that purpose, we are sharing the most common misconceptions surrounding 1031:
The properties have to be of the exact same kind for a like-kind exchange
The real condition here is for both the properties to be sold and purchased for productive purposes such as for trading, business, or investments. With that taken care of, properties exchanged can be of whatever type. For instance, a taxpayer can sell an industrial warehouse and exchange it for an apartment building.
As long as I have access to the money, I can exchange whenever I want, even after the closing
This misconception gets many people in trouble when they belatedly realize that they no longer can benefit from the exchange after the closing.
No matter how you look at it, once you have sold the property, and have the means to access the proceeds, the exchange has already invalidated it. Once the deal is closed, the boat has already sailed. There’s an entire procedure that requires an exchange agreement, assignment of the contract as well as notice of that assignment prior to the sale.
Upon terminating the exchange and paying the tax in full, I’ll get my exchange funds at any time
We don’t blame anyone for this misconception since it makes complete sense, yet the regulations state otherwise. The only condition where you get the funds back is when you fail to find an exchange property within 45 days of the sale of the relinquished property.
There are some other conditions that allow the taxpayers to receive their funds. Unless those conditions are met, the return of funds is not always a guarantee.
My vacation property is a perfect chance for me to avail the 1031 exchange upon selling it
If you’ve had that planned all along then, we are sorry to burst your bubble, but that’s not possible, or hardly possible. Properties for personal use are not applicable for 1031 exchange. Even if that vacation home has been rented a few times, it will still not fall under the exchange regulation.
If you are still all confused by somewhat tricky regulations surrounding 1031 like-kind exchange or have been hearing about it for the first time, seek legal guidance. In fact, legal guidance would be the wisest act on your behalf if your trade is selling and buying properties.