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Selling? Defer Taxes with a 1031 Exchange

Farmland in ColoradoThe 1031 Exchange has been called one of the most powerful wealth-building tools available to taxpayers. However, it’s also one of the most underutilized sections of the tax code perhaps because of its name. Calling the procedure an exchange creates misunderstanding; so think of it as a 1031 rollover because that’s precisely what happens.

Taking its name from Section 1031 of the Internal Revenue Code, it allows a taxpayer to sell income, investment or business property and replace it with a like-kind property. Capital gains from the sale of property are essentially rolled over to a new property to postpone paying tax. The ultimate goal is to make this tax disappear by one of two ways:

  1. Sellers may successfully rollover gain and ultimately move into one of their investment properties and declare it to be their primary residence. Provided they are married and have held the property for five years and reside in the property for a minimum of two years, they can exempt $500,000 in taxes upon the ultimate sale.
  2. Capital gains taxes are eliminated upon the death of the property owner. Heirs receive a step up in basis on the date of death.

As with anything, there are many rules in place for 1031 Exchanges, meaning they’re not for the do-it-yourself investor. For advice on whether a 1031 Exchange is right for you, consult with your tax professional.