The term “1031 Exchange” in itself can be daunting as it gets thrown around often. Many people don’t fully understand what it entails but may actually heavily benefit from it. Here’s what you should know (in very black and white terms) if you’re considering this savvy option for investing in, or transferring real estate.
First, let’s discuss what is a 1031 Exchange? Section 1031 is usually associated with the commercial real estate industry, and once applied to personal property, artwork, aircrafts, commercial fishing boats, and more (but this is no longer the case). This action allows an investor to defer any capital gains taxes that would be due as a result of the sale, i.e. rental home or commercial building. If earnings from the sale are reinvested, those taxes could be avoided altogether. On the contrary, if the investor were to outright sell the investment property without the intent to put the funds toward another property, they could face capital gains taxation upwards of 20-30%; Ouch.
Now that we have a basic understanding of what 1031 Exchanges are, let’s dive a little deeper and simplify the hairier details.
5 Ways to Simplify 1031 Exchanges –
- Rules & Regulations –
- The replacement property the funds are transferred to in the reinvestment must be like-kind, meaning, residential property for residential property, large commercial building for large commercial building, vacation home for vacation home.
- Both titles must list the same owner for accuracy
- Reinvestment must take place. The total value of the replacement property needs to be equivalent, or more than, the previously sold property to avoid capital gains taxes.
2. A Further Look, Rules & Regulations – You only need to satisfy one of the three main rules when it comes to 1031 Exchanges. Just remember “3-95-200“.
- Identify up to 3 potential replacement properties, purchase any, or all of them, no matter their total value to properly complete the exchange.
- This is not commonly used by investors, nevertheless should be talked about. This lesser-used option essentially allows and investor to name any number of potential replacement property of any value covering 95% of the total value of all properties owned, but there’s a downside. In light terms, while it may seem like the easiest option, read more into it, as it could actually lead you, the investor, with a bigger purchase commitment than anticipated.
- Lastly, you have the option to identify more than 3 potential replacement properties, so long as their value does not exceed 200% of the total of the released property.
3. The Process – This one’s a peace of cake, just make sure to complete everything within the deadlines detailed in our fourth step. Keep in mind, the sale must be made into an exchange before the close of escrow of the relinquished property, otherwise, things get messy. Similarly, be sure to employ a Qualified Intermediary before you close the sale. Now, here we go:
- Disposition of the original property (Selling it)
- Great, now you have sales proceeds, or capital
- Identify single or multiple replacement properties for investment
- Take sale proceeds to your previously identified, qualified intermediary (this cannot be an agent you’ve worked with within the past two years on the sale of that property)
- Take the investment capital and acquire a replacement property.
4. Deadlines – Set up your calendar, these are important dates.
- Days #0-45: Sell the property and identify what is next you’d like to invest in, property-wise.
- Day #45: Complete the identification or probable replacement property/properties.
- Day #180: Close escrow on the replacement investment property within this time frame, or 180 days after the disposition of the sold property.
5. Resources – Certainly it’s wonderful to understand what you’re getting into, potentially, by educating yourself in 1031 exchanges. If you, or someone you know is interested in learning more and going through with a 1031 exchange, leave it to the experts and avoid hefty capital gains taxation.
Discover how the experienced and qualified professionals at CSR Real Estate Services, both residential and commercial, can help you find and close on your next 1031 exchange property or to learn more about the exchange process.