1031 Exchange Explained

Property owners that are looking to sell in Houston, Texas may benefit from a 1031 exchange.  Learn about 1031 tax exchanges here!

The IRS regulation "1031" provides specific tax benefits for homeowners, whereby selling one home and then purchasing another within 180 days, can be treated as an exchange, versus a sale that would be treated as capital gains income.

Exchange Treatment

Normally, once a property is sold, the owner is taxed on the gains (the difference between what the property is sold for vs what you originally bought it for) made from the sale of a property.

Instead, if the property is "exchanged," the IRS rules allow for the deferral of owed capital gains taxes.

1031 Exchange Rules

The 1031 Tax Exchange rules are outlined in the U.S. tax code and treasury regulations. In order for a property to be eligible for these types of exchanges, the property must fall within specific boundaries. The first rule is that the property that is being exchanged must be “like” property. For instance, any property that is located within the United States is considered “like-kind."  Property outside of the United States typically can not be included in 1031 exchanges.

Additional rules specify that the property to be acquired must be of equal or greater value than the property that it is being exchanged for.

There is an exception rule within the 1031 Tax Exchange. Certain types of property may be excluded, even if they are located within Houston, or other areas of the United States. These exclusions include: property that is being held for sale for a profit, inventories, stocks, bonds, and notes, other securities or evidence of indebtedness, if the owners are looking at a partnership, and other beneficial interests.

Then there is the exchange component of the 1031 Tax Exchange. For property owners to be eligible for the 1031 Tax Exchange, the property must actually be exchanged, instead of the property being sold and then the owner using the money from the sale of that property to purchase another. That type of transaction would be viewed as a simple sale of property and would not be eligible for a tax exchange.

Arm's Length Transaction

Another rule written into the U.S. tax code states that any funds from the original sale of property, must not go to the property owner or the property owner’s agent. Instead, they must be given to a qualified intermediary. That qualified intermediary is generally an individual, or company that works exclusively with dealing with 1031 tax exchanges.

They must have no other contact with the owner other than serving as a qualified intermediary for the exchange that is about to take place. The intermediary will be responsible for holding funds related to the exchange and for distributing them as needed. If in the end there are proceeds that are rightfully the owner’s, those funds will be taxed.

1031 Timelines

In addition to the different rules that accompany a 1031 tax exchange, there are also certain timelines that must be adhered to. There are two timelines specifically that must receive particular attention. The first timeline is the Identification Period.

This refers to the amount of time that a property owner has to find replacement properties that he is interested in purchasing. This time period is within 45 days of selling the original property. The 45 days is 45 days exactly and includes holidays and weekends. This timeline will never be extended and if an owner cannot find replacement properties within that time, the property that had been sold will no longer be eligible for a 1031 tax exchange.

The other timeline property owners must concern themselves with is the exchange period timeline. This refers to the period of time that a property owner selling his property must become owner of another property. The time period for this is 180 days from the time the original property is sold. The time period is over on the date the property is fully relinquished or when the person’s tax return for that current year is due, whichever date comes first.

So while property owners in Houston, Texas may want to further investigate 1031 Tax Exchanges to see if they are eligible tax benefits, it’s important to fully understand this tax code to ensure that you meet all the rules and requirements that will make you eligible.

Search Houston Homes For Sale