Arizona real estate investors can be involved in multiple purchases and sales of properties. Usually, when these transactions result in a profit, the investor will owe taxes on his or her gain. However, when the investor decides to take the earnings and reinvest them in a 1031 exchange, they may be able to defer their capital gains assessment. When used correctly, 1031 exchanges can give investors the freedom to explore new ventures without having to incur immediate tax liability. You may want to know: Can I use a 1031 exchange for my Arizona commercial transaction?
The 1031 Exchange
IRS code Section 1031 allows property owners to sell and buy similar investment properties with the proceeds of the sale. This transaction is viewed as an “in-kind” exchange, and the investor will only owe capital gains taxes to the extent that he or she realizes a profit. When an investor meets the Section requirements, he or she will owe few if any taxes on the sale. The owner will owe taxes only when they decide to stop reinvesting their profits. As long as he or she keeps selling and investing in in-kind property, the IRS views the investment as changing form without realizing a gain.
How 1031 Exchanges Work
Under the recently passed Tax Cuts and Jobs Act, Section 1031 now applies only to exchanges of real property and not to exchanges of personal or intangible property. 1031 exchanges are only allowed for investment properties, and there is no limit on the number of times an investor can complete an exchange. To qualify for 1031 treatment, properties being exchanged must be of “like-kind.” According to the IRS, properties are considered “to be of like-kind if they’re of the same nature or character, even if they differ in grade or quality.” Although an investor may realize a profit from each exchange, the 1031 exchange process allows them to defer paying capital gains taxes on the in-kind portion of the transaction until they decide to stop reinvesting.
During the 1031 process, an investor sells his property, and then the proceeds will be given to a designated intermediary. The owner has 45 days after the sale to select the replacement property in writing and notify the intermediary. The owner can name up to three properties, as long as he or she actually closes on one of them. The closing must occur within 180 days of the sale. Any capital gains that remain after the sale are paid to the owner and are subject to taxation.
1031 exchanges can be an effective means for a commercial property investor to defer capital gains taxes while exploring new business ventures. However, these transactions can be complicated, and it is essential to consult with a qualified real estate attorney to discuss their requirements and any other issues concerning your investment property interests.
Laura B. Bramnick is an experienced real estate attorney who can help you manage issues related to the purchase and sale of your Arizona commercial investment property, including eligibility and consequences of 1031 exchanges. If you are seeking an exceptional, client-driven real estate lawyer in Scottsdale, Phoenix, Sedona and throughout the State of Arizona, contact Laura B. Bramnick to schedule your consultation.