1031 Tax-Deferred Like-Kind Exchanges refer to the IRS's regulations on the ability to defer taxes on like-kind property exchanges. The IRS allows someone who sells land only to buy replacement property to then defer taxes until he sells the replacement property. However, in spite of the risks, there are a lot of benefits that can outweigh the risks depending on the situation.

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Identification time period puts everyone on notice

To qualify for a 1031 tax deferment, the purchaser must follow the 45-180 rule. The rule basically states that the replacement property must at least be identified within forty-five days after the original property sold. The replacement property must be purchased within 180 days of the sale of the original property. This benefits both buyers and sellers because it puts them on notice of the pending change in taxation categories, allowing them to structure their negotiation strategies accordingly. For real property purchases, the requirement is somewhat moot as almost all states require registration at the local courthouse. However, for equipment and other purchases, the notice is not generally required.

Like kind eliminates need for additional complex calculations

The second main requirement is that the property must be of “like-kind.” While this may seem to limit the options, it actually makes the process easier because it eliminates the need for additional complex calculations. The rules for like-kind exchanges are fairly loose when it comes to real property. Most land is like-kind with other land, even if one parcel has a house on it and the other does not. Fixtures and personal property attached to the real property generally do not affect its like-kind nature. The rules for personal property like-kind exchanges, however, are far stricter. For example, livestock is not of a like-kind with a truck, even though both are used on a farm. A car is not of like-kind with a truck, even though both are vehicles. The key to like-kind exchanges is the type of use the property is used for and its primary descriptors. Land is generally used to build or grow things on. There is not much difference among lands, even if it is used to grow different crops or for residential purposes.

Ability to postpone tax payments

There are many benefits to claiming a 1031 tax deferment. By claiming this deferment, you can postpone income taxes on the qualifying properties. Normally, taxpayers pay taxes on all profits they make on a transaction, even if those profits are used to purchase something else. For example, if you buy land for $10,000 and then resell it for $15,000, then you made $5,000. You will be taxed on that income even if you put the $5,000 toward purchasing a $20,000 property. Even though you are still $15,000 in debt at this time, you would normally still pay taxes on your $5,000 income. Simply using the proceeds from selling one property to purchase another does not qualify for tax deferment. However, if the second property is being used to replace the first property in a continuing property exchange, then the exchange may be considered for a tax deferment.

Failure to Complete a Deal the Greatest Risk

The risks of attempting to claim a deferment include rejection and having to pay the taxes, particularly if the deal could not be completed. If the replacement property cannot be purchased for whatever reason, then the buying party must still pay taxes on the purchase. If it turns out that the timing of the sale or the denial extends beyond tax season, you could wind up having to pay a penalty. Most of the time, the government or IRS's delay in approving such a request is not sufficient grounds to waive the fees and penalties that come from being late. The best way to avoid the increased penalty risk is to request an extension if you realize that you won't know until after the due date. It's free to file, and it will save you most of the punitive damages. If the IRS does deny the property or you are unable to follow through on your own requirements, you'll be expected to pay the taxes in a timely manner. The actual rate will depend on the property you sell.

If you need more help with a 1031 tax deferment, talk to a tax lawyer for more information.

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