Many people have no idea what a 1031 exchange is, but hear of it when it comes time to sell off property. This article is intended for those people. I have written this in the simplest way that I can so that it can be understood by all.
First, to understand what a 1031 exchange is, you should understand the purpose behind it. The whole concept behind a 1031 exchange is to defer some taxes (capital gains tax) from the sale of that property, when you plan to invest the profits from that sale directly into another property. People do this so that they do not lose any equity in the transition from one property to another.
Now that you grasp the purpose of a 1031 exchange we can talk about how you accomplish this. To start with, the law requires you to hire a qualified 3rd party to assist you in this by advising you and holding the proceeds from the sale of the current property until you reinvest them in the new property. These people or companies are called a QI – Qualified Intermediary.
Next, there are some guidelines about what qualifies for a 1031 exchange. 1031 exchanges involve property. Generally, this would refer to single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities. There are some things that are excluded from 1031 exchanges and you can find those by asking a QI about them.
One of the main factors is that the properties need to be of like kind. Like kind is referring to the nature or characters of properties, not the grade or quality. Another factor in 1031 exchanges is that the properties must be held for productive use in trade or business or for investment.
There are a lot of other specific rules that the IRS has for this kind of exchange and that is likely why they require anyone who does this to use a qualified professional trained in this. However, there are some general guidelines that you should be able to understand and may help guide you in your decisions on your plans for investments if you are looking into this.
1- The value of the replacement property must be equal to or greater than the value than the old property that you are selling. 2- The equity of the replacement property must also be equal to or greater than the value of the old property that you are selling. 3- The debt on the replacement property must be equal to or greater than the debt of the old property that you are selling. 4- ALL of the net proceeds from the old property that you are selling must be used to acquire the replacement property.
There are also some timeline issues that you will want to be aware of. First, in order to successfully qualify for a 1031 exchange, you will need to identify a new property by the 45th calendar day from the time of the closing on the relinquished property. (There are guidelines about that too – see a professional) Second, you need to close on the new property by the 180th calendar day from the time of the closing on the relinquished property. Hopefully this helps. Please call a professional when you are getting ready to consider a 1031 exchange.
As you look around for more info about a 1031 exchange, remember that some also call it a 1031 Tax Exchange. Always remember to consult a Qualified Intermediary before making any decisions.
