The ins and outs of tax-free exchanges

On Behalf of | Dec 13, 2019 | Income Tax

Most Connecticut residents are always on the lookout for ways to lower their tax liabilities. No one wants to pay Uncle Sam more than they have to, so it is understandable. Unfortunately, there are only so many ways that one can do this without raising any questions over legality. For business owners or those who have investment properties, tax-free exchanges are one way to avoid overpaying taxes on capital gains from the selling of property.

How do tax-free exchanges work? Generally, when a property is sold, capital gains tax applies to any proceeds earned — over a certain amount. With tax-free exchanges, capital gains tax can be avoided if there is an exchange of what is considered like-kind properties — which means the money from the sale is reinvested. So, say a person owns a home as an investment property. Under the 1031 exchange program, if he or she sells the home, capital gains taxes can be avoided if the proceeds are invested in a new home or similar investment within a specific time frame.

Tax-free exchanges were not always limited to real estate. However, with the passing of the Tax Cuts and Jobs Act, only real estate can now be claimed under the 1031 exchange program. To do this, though, one has to have identified a replacement property within 45 days of selling one property, and the new property has to be secured within 180 days.

Tax-free exchanges are used to reward those who take part in various business and investment opportunities. The challenge is using the 1031 exchange program correctly. This is a tax-deferred strategy that can cost Connecticut residents a pretty penny if incorrectly utilized. Thankfully, legal counsel can answer any questions one has about tax-free exchanges and help one file the necessary paperwork to take advantage of this program.