How to Use the 1031 Exchange

By Kelly Quigley, REALTOR® Magazine

The Tax-Free Exchange Loophole by Jack Cummings (John Wiley & Sons Inc., 2005)

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A loophole written into the U.S. tax code allows you and your clients to never pay capital gains taxes on a real estate sale, as long as the profits are reinvested into a similar property. But you can’t fully enjoy all of the benefits it provides unless you know the rules—which are intimidating, to say the least. This book attempts to make the intricacies of the 1031 tax-free exchange easy to understand and use in your own real estate deals. Written in what the author calls a building-block style, the book explains all the terms you need to know and uses real-life transactions to show how the 1031 exchange and other tax loopholes work. Although it reads much like a text book—requiring a fair amount of determination on the reader’s part—it is a good first step to grasping the complex rules that can save you lots of money.

Tips From the Book:

  • Plan 1031 exchanges well in advance. Using 1031 exchanges should not be a last-minute thing; it should be a major strategy in your arsenal of investment tools. If you know you’re going to sell a property in which there where will be taxable gain, then review your situation before you put the property on the market. Be careful about accepting an offer if you have not found a suitable replacement property; under normal circumstances, a 1031 exchange requires you to identify a replacement property within 45 days of closing.
  • Work with up-to-date experts. Because IRS codes are always in a state of flux, anything you learn today about 1031 exchanges can change tomorrow. To make sure you are using the laws properly, you need to make sure that the accountant and lawyer you use for your exchange deals are fully up to date. So-called experts who deal with just one or two exchanges a year may not have the experience to earn your trust.
  • Tap into a local exchange club. There are exchange groups scattered around the country that you can join to learn more about how to use 1031 exchanges. The clubs are made up largely of real estate practitioners and brokers and can be a great resource for the finer points of making exchanges. You also can use the clubs to find tax-free exchange experts in your area who can help you with your deals. Search the Web to find a club in your area.
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