Navigating the §1031 exchange process can be challenging for real estate investors that are unfamiliar with the rules and regulations. Here are some of the most common §1031 questions our team receives, including:
- What Is a §1031 Exchange?
- What Properties Qualify for a §1031 Exchange?
- What Properties Don’t Qualify for a §1031 Exchange?
- Who Uses §1031 Exchanges?
- What Are the Benefits of a §1031 Exchange?
- Are There Time Requirements for a §1031 Exchange?
- What Are the Different Types of §1031 Exchanges?
- What Is the §1031 Exchange Holding Period?
- How Does the §1031 Exchange Process Start?
- What Is an Exchange Facilitator?
- Do I Need to Work With a Qualified Intermediary?
- What Is the §1031 Exchange Intermediaries Process?
A §1031 exchange is an IRS-approved tax break that allows real estate inventors to sell a property held for business or investment purposes and swap it for another without paying the capital gains tax.
It’s a strategy that enables investors to upgrade the properties they own, avoid unwanted taxes, and keep more of what they earn.
Any property that you hold for productive use in a trade or or business or for investment purposes can be exchanged for a like-kind property. A single-family residence can be involved in a §1031 exchange for a duplex, raw land for a commercial property, or an office for apartments.
Personal property, including residence, second home, or vacation home, is not eligible for a §1031 exchange. Also, the IRS excludes the following from their like-kind specification:
- Stock in trade or other property held for sale
- Stock, bonds, or notes
- Other securities or evidences of indebtedness
- Interest in a partnership
- Certificates of trust or beneficial interests
- Choses in action
A §1031 exchange is a tax incentive available to and used by taxpayers of various backgrounds. All businesses, manufacturers, real estate investors, and leasing and construction companies can leverage §1031 exchanges to their benefit.
Using a §1031 exchange offers investors various benefits, including:
The primary benefit of a §1031 exchange is it reduces an investor’s tax burden. It enables them to defer the capital gains tax and frees up more equity for investment in the replacement property. This ensures they receive more of the money they earn and helps them build long-term wealth.
§1031 exchanges benefit property owners by allowing them to write off the depreciation of their asset and compensate for the aging and wear and tear of their investment. This helps them reduce the amount of income taxes they pay over the long term and provides additional financial benefits.
§1031 exchanges allows investors to improve their wealth by using a portfolio diversification strategy. It enables individuals to optimize investments by purchasing various property types, locations, or asset classes.
§1031 exchanges have strict time requirements. From the day after you close on the sale of your property, the investor has 45 days to indicate their potential replacement investment and a total of 180 days from closing to finalize their new purchase. Any delays in either area means their §1031 exchange is void, and they have to pay the capital gains tax.
There are several §1031 exchange strategies that investors can use. The type utilized depends on the situation and their long-term goals.
A simultaneous exchange is when an investor or company sells their existing property and purchases a replacement one at the same time. This is a challenging strategy that requires significant attention to detail and strong logistical organization because delays can disqualify the benefits.
A deferred §1031 exchange is the most common strategy and occurs when an investor sells their property before buying their replacement investment. One reason why this method is popular is because it gives the individual plenty of time to find their new building. However, a third party must hold the process from the sale for a maximum of 180 days, or they will have to pay the capital gains tax.
A reverse §1031 exchange is a strategy where the investor purchases their replacement investment before selling their existing property. In this scenario, the individual must declare the real estate to offer as relinquished property within 45 days. They then have 135 days to complete the sale and close their exchange. This is a difficult process because they can’t own the old and new properties at the same time.
An improvement exchange is a strategy that enables investors to upgrade the replacement property using the equity earned by selling their previous investment. This is ideal for individuals who want to improve a facility that doesn’t meet their needs. Executing an improvement exchange is difficult because all renovations must be completed within 180 days of the sale.
To qualify for a full tax deferral on an investment, an investor must hold their property for a specific period of time. While that isn’t explicitly defined, usually it’s between one and two years.
The §1031 exchange process starts with a phone call to an exchange facilitator. Before calling, make sure you have the right information to start the process off on the right foot. This includes the addresses, file numbers, and potential properties you wish to invest in
An exchange facilitator is an independent consultant and serves as the main point of contact with investors during the §1031 exchange process. They make sure all details are covered and verifies that everything is accomplished on time.
Whether or not you need to work with a qualified intermediary depends on the type of §1031 exchange you’re using. If you’re executing a deferred exchange, then you must work with one. These transactions require an independent third party to hold the money from the property sale before it’s invested in a new purchase. If you, your realtor, financial manager, or anyone else who may profit from your investment handle the proceeds, then you’ll have to pay taxes.
The 1031 Exchange Intermediaries team understands the value of keeping everything on schedule. That’s why we utilize an end-to-end process that eliminates delays and provides a stress-free experience:
Our process begins with a consultation where one of our qualified intermediaries assesses the situation and determines which exchange strategy is best. We also estimate the projected tax liability to demonstrate how much the client is saving.
Unforeseen errors and delays can significantly impact the viability of an exchange and cause the IRS to challenge it. Our team takes time to verify it’s meeting all conditions and guidelines before moving to the final stage of the process.
Once we ensure your exchange meets the IRS’s rules, our team sets up the mechanics and completes the exchange. Our attention to detail provides peace of mind knowing the exchange will be successful.