One of the strategies available to postpone, or defer, capital gains taxes is by selling a business or investment real estate property in a 1031 exchange. Section 1031 of the Internal Revenue Service Code gives individuals and businesses the option to invest the money from the sale of business or investment property into a similar property with the benefit of a postponement of paying capital gains taxes. Please note, you are not relieved of your tax obligation on the profits from that sale because you used a 1031 exchange. It simply means you are deferring them until a later date by reinvesting them in a “like-kind exchange.”
The use of 1031 exchanges in Arizona can be a great tool to build wealth, but there are risks and penalties if the process is not handled correctly. M&G Law put together an overview of 1031 exchanges in Arizona to help you understand if it could be a good option for your investment property.
1031 Exchange Rules in Arizona
You cannot simply sell a property, buy a new property that is similar, and retroactively call it a 1031 exchange. In order to set up a 1031 exchange in Arizona properly, you will need to start the process with a qualified intermediary, also called an exchange facilitator, before proceeding with the sale of your current business or investment property.
Attorneys, tax professionals, banks, investment advisors, and others can serve as qualified intermediaries for a 1031 exchange. It’s obviously important to find a professional you can trust with knowledge of real estate and tax law in Arizona.
1031 exchanges require an exchange agreement between the property owner and exchange facilitator that covers the sale of the existing property and the acquisition of like-kind property as part of an integrated transaction. Thus, the seller must execute a written agreement with the qualified intermediary before closing on the sale of the existing property.
The exchange facilitator ensures that you or your business do not directly take receipt of the gains from the sale of the first property and makes clear your intention to utilize this strategy to defer the tax obligation before purchasing the like-kind property. To do so, they will hold the funds from the sale during the 45-day identification period, which will be discussed below.
1031 Exchange Checklist and Documents
The most important step on a 1031 exchange checklist is finding an experienced exchange facilitator. An experienced qualified intermediary will help you make sure that your business or property qualifies for a 1031 exchange and draft the exchange agreement with the appropriate structure for the integrated transactions if they do. To help, there are professional organizations such as the Federation of Exchange Accommodators, which is a professional organization for qualified intermediaries.
Once your current property sells and the qualified intermediary has the funds from the sale, you will generally have 45 days to identify the like-kind property you intend to purchase. The identification of the like-kind property you intend to purchase must be provided in writing to the seller of that property or the qualified intermediary.
It is generally a good idea to inform both parties. You will be required to clearly describe all legal details of the replacement property in this identification, including legal description, street address or a distinguishable name for the real property. The purchase of the replacement property or properties must be completed within 180 days of the sale of your original property or the tax payment deadline for the tax year that property was sold in. Completing all steps of the process in the allotted timelines is essential for utilizing a 1031 exchange.
What Constitutes Like-Kind Properties for a 1031 Exchange?
There is plenty of flexibility in what qualifies as a like-kind property or business as long as the property was held for investment purposes. The IRS definition of “like-kind” property simply states that both properties are the same nature, character or class. Section 1031 makes clear that the definition of “like-kind” leaves room for some interpretation, for example vacant land is considered like-kind to residential and commercial real estate.
There are a few important distinctions to like-kind rules that should be understood before proceeding with a 1031 exchange. You cannot sell property in the United States and use a 1031 exchange to purchase foreign property. The IRS also makes clear that personal property cannot be considered like-kind to real property and improvements to real property are not like-kind to land.
Making sure your intended properties qualify as like-kind is another reason to work with a qualified intermediary with significant experience in 1031 exchanges. You should have some idea of the intended property type for purchase, if not a specific property, before starting a 1031 exchange. This will help you make sure that your intended property will qualify for the valuable tax deferment before starting the process and one of the main reasons to work with an exchange facilitator with lots of experience in Arizona real estate law.
Find an Experienced Arizona 1031 Exchange Facilitator
The attorneys at M&G Law can represent your interests and handle all the details and documents for a 1031 exchange in Arizona. The process is not overly complicated, but it’s vital that you handle all steps of the process correctly within the allotted timeline in order to avoid costly penalties. Our firm works with clients to craft a plan for 1031 exchanges in Arizona and guides them through every step of the process. Call us today at 602-533-2840 to schedule an initial consultation or make an appointment online.