A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
The Combined Rate accounts for Federal, State, and Local tax rate on capital gains income, the 3.8 percent Surtax on capital gains and the marginal effect of Pease Limitations (which results in a tax rate increase of 1.18 percent).
Delaware allows some or all of federal income tax paid to be deducted from state taxable income. Delaware allows for a Tax Credit instead of a deduction for taxes paid in other states. In addition to the personal income tax rates, Delaware imposes a tax on lump-sum distributions.
In terms of the 1031 exchange process itself, there isn't anything particularly unique about Delaware compared to other states in the U.S. The rules and principles governing a 1031 exchange, as outlined in Section 1031 of the Internal Revenue Code, apply uniformly across all states. This means that the basic requirements, such as the need for the properties involved in the exchange to be held for investment or used in a trade or business, and the like-kind nature of the properties, remain the same whether the exchange involves properties in Delaware or elsewhere in the country.
However, Delaware does have a unique investment structure known as the Delaware Statutory Trust (DST) that is often used in conjunction with 1031 exchanges. A DST allows multiple investors to pool their money to hold fractional interests in real estate. This can be particularly advantageous for 1031 exchange investors who are looking to diversify their holdings without managing the properties themselves. By investing in a DST, an investor can potentially meet the like-kind requirement of a 1031 exchange while also spreading their investment across multiple properties or even geographic locations.
DSTs are offered as investment vehicles and, as a legal entity, can own different types of property located in any geography -- They are not unique to investments located in the state of Delaware.
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
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