If you are a property investor, then you have heard of the 1031 exchange. However, not everyone knows what it means or why it might be an important program to consider. But there is nothing wrong with that. The 1031 exchange is only important if you are looking to sell an investment property.
What Is A 1031 Exchange?
A 1031 exchange received its name from the US’s Section 1031. International Revenue Code is a way of postponing capital gains tax from the sale of a given property or business. It is worth noting that not everything will qualify as a 1031 exchange.
Now, let us look at when you are supposed to consider a 1031 exchange
When Would You Want To Do A 1031 Exchange?
As already said, there are only specific reasons you would find that 1031 exchange is the best solution. But as an investor, you would prefer something that protects you from paying taxes. That is what most real estate investors opt for 1031 exchange, as long as conditions favor them.
The more money you pay in taxes, the less money you will be left with to reinvest. Thus, you have all the reasons to use 1031 exchange each time an opportunity presents itself.
To expand your portfolio, you need to find a way to roll more and more proceeds into your real estate investment. Unless you do that, a part of your investment will have to go to the government, which bad news.
Your ability to expand your portfolio will have been reduced. If you are looking to save money, then a 1031 exchange is something you need to consider.
What Are The Rules To Keep In Mind?
The first rule is that it is impossible to sell an investment property, buy another one and then attempt to start the 1031 exchange. You must start the process before someone buys the property. Therefore be careful not to wait until it is too late.
The next rule is that an investor can never do the 1031 exchange on their own. In that case, if you plan to do one, then begin looking for an experienced intermediary. This is a company whose job is to facilitate 1031 exchanges. This is not a process that you can do yourself.
There is always an identification period rule. It states that you must start the process within 45 days of selling your property. Also, when doing that, you are supposed to have identified ideal replacement property.
The property you are exchanging into must have an equal value to the one you had sold. Unless you meet that threshold, you will not qualify for the program. But if your property of less value and you earn cash from the deal, you will be requested to pay taxes on that particular cash.
Important Points to Note
Apart from the information we have shared, there are more requirements and qualifications worth knowing. We have listed them below.
The first point is that you will still have to pay tax later. Note that the duty of the 1031 exchange is not to expunge the capital gains tax. The idea is to postpone it for you. Therefore, be ready because the capital gains tax bill will come your way later.
Note that the properties don’t have to be as much similar as you might think. As an investor, you don’t have to sell a rental property and then replace it with a similar rental property. Also, you don’t have to replace a parking lot with another parking lot.
The final rule is that relationships matter a lot. This means that your exchange facilitator of intermediary can’t be your banker, relative, attorney, real estate agent, or accountant. Consider learning more about how Delaware statutory trust works to see if it can alter your investment situation.
Individuals who have worked with you in the capacities mentioned will not be qualified to serve as your exchange facilitator. Last but not least, you can never serve as your intermediary; you must find someone else or a company.
Closing Thoughts
As an investor, you would prefer something that protects you from paying taxes. That is what most real estate investors opt for 1031 exchange, as long as conditions favor them. However, it is impossible to use the exchange if the property in question has already been sold.
