Taxes may not be the most enjoyable topic to think about, but when it comes to buying land, it's definitely a subject you shouldn't let fall by the wayside. Case in point: The Section 1031 exchange.
What is the Section 1031 exchange?
As outlined by Kevin Teston of Mossy Oak Properties of Augusta in Augusta, Georgia, Section 1031 can be a valuable tool for investing in land.
"Section 1031 is part of the Internal Revenue Code that details a method by which a property owner trades (tax-deferred exchange) one property for another without having to pay any federal income tax on the transaction at that time," Teston said. "By using the exchange, the tax on the transaction is deferred to some point in the future, usually when the newly acquired property is sold. Tax-deferred exchanges are useful in buying land because a buyer can use proceeds from another real estate transaction to acquire land, or a buyer can sell an existing appreciated tract in order to acquire a larger tract, while deferring federal income tax to a later date."
In short, instead of only being able to reinvest in rural land with the money you receive after taxation, you can defer your federal income tax and purchase land before taxation has a chance to bite into your funds. For individuals who plan on investing in land, this can be an incredibly beneficial strategy.
Qualifying for a Section 1031 exchange
Before you get too excited about the possibilities of this tax tool, one thing to keep in mind is that a Section 1031 exchange isn't something you can always depend on.
"In order to qualify for a tax-deferred exchange under Section 1031, certain requirements must be met," Teston continued. "First it has to be qualified property, which in most cases will be real estate. The property must be held for investment, and there is a like kind requirement, which means 'similar in nature or character, not withstanding differences in grade or quality.' There is a minimum holding period for the property to be exchanged and there are time limits for finding a replacement property. In other words, you can sell one property and exchange it for a another property you purchase within a certain time frame in the future."
The rules regarding a Section 1031 can be complicated, so Teston recommended land buyers acquire the services of experienced accounting and legal professionals before making any major moves.
However, together with the help of a practiced land specialist, there's no doubt a Section 1031 exchange can give land buyers the edge they need when it comes time to invest in rural real estate.