This IRS tax rule can help owners save on capital gains taxes by reinvesting in their business.

Selling a building, property, or other business-related real estate is a big step for any business owner. While tax implications of a large real estate sale may seem overwhelming, understanding Section 1031 of the Internal Revenue Code can help you save money and build your business. You just need to make sure you reinvest the proceeds appropriately. Learn more about how a 1031 exchange works, what properties qualify, and who can help you navigate the process.

What is a 1031 exchange?

A 1031 exchange is very straightforward. If a business owner has property they currently own, they can sell that property, and if they reinvest the proceeds into a replacement property, there’s no immediate tax consequence to that particular transaction. They can defer any capital gains taxes associated with that sale.

This formerly applied to other types of business assets, but changes to the tax code now limit its application to real estate assets. Still, there are rules regarding what types of real estate qualify and the required timeframe of the transaction.

What types of properties qualify?

To qualify as a 1031, both properties involved in the exchange must be “like-kind,” meaning they must be of the same nature, character, or class as defined by the IRS.

A few key points to know:

  • Most real estate properties are classified as like-kind.
  • A property within the U.S. may only be exchanged with other real estate within the U.S.
  • A property outside the U.S. may only be exchanged with other real estate outside the U.S.

How does the process get started?

When you sell your existing investment property, you’ll want to work with a qualified intermediary (QI). A QI may be a CPA with 1031 experience, a real estate attorney, or a bank, such as Wells Fargo. Typically, before the relinquished property is sold, its owner and the QI will enter into an exchange agreement in which the QI is designated to receive funds from the sale and will then hold and safeguard those funds throughout the transaction. A QI can also consult with the business owner on how to remain in compliance with the Internal Revenue Code.

When must the transaction be completed?

While the overall exchange process may differ for each transaction, there are specific deadlines that apply to any 1031 exchange. After the sale of the relinquished property, the business owner must identify all potential replacement assets within 45 days. They then have up to 180 days from the sale date of the original asset (or until the tax filing due date, whichever comes first) to complete the acquisition of the replacement property.

Where do I start?

Seeking a QI is the first step in processing a successful 1031 exchange. Make sure you work with a high-quality intermediary, such as a bank. There is no regulation over QIs so using someone with experience and knowledge is important.

Also, speak with a tax advisor who can help with guidance to your particular transaction. And as you make big decisions about your small business, make an appointment with a Wells Fargo banker who can provide products and services designed for your needs.