A 1031 exchange can help real estate investors defer capital gains taxes. But you need to know how to do a 1031 exchange. Here are 5 things to do first.
In a world of increasingly high taxes, a 1031 exchange can feel like a gift from the heavens. The exchange, named after a section of the IRS regulations, allows savvy investors to defer, or even completely avoid capital gains tax altogether.
The 1031 is essentially an investment property exchange. This means that you can avoid capital gains tax by re-investing the revenue into a similar property. The process of undergoing a 1031 exchange investment isn’t for beginners, as there are a lot of rules and stipulations.
Here’s what you need to know about how to do a 1031 exchange.
How to Do a 1031 Exchange: Find Out if You Qualify
You can’t just class any property exchange as a 1031 investment. You need to make sure the assets in question fit the strict rules laid out by the IRS. Most importantly, the properties involved in a 1031 real estate exchange must be “like-kind”. This means the property you are selling and the property you are placing the sales revenue in must be similar.
They must be for business or investment purposes, and not your primary residence. These can include offices, malls, land, and industrial buildings.
Know Your Time Restrictions
You will only have a limited window of time in which to complete a 1031 exchange real estate. According to IRS rules, you will have 45 days, including weekends and holidays, from the sale of the property to either close on or identify a replacement property. This is non-negotiable.
Similarly, once a replacement property is found, you will have 180 days exactly to close on that sale and assume ownership of the property.
Choose the Right Value Replacement Property
If the value of your replacement property is any less than the value of the one you have sold, you will be liable for taxation. The 1031 rules stipulate that the replacement property must have greater or equal value to the one you are selling.
Fortunately, any other costs associated with acquiring the replacement property can be added to the “value”. These include realtor fees, inspections and broker costs.
Find an Intermediary
1031 investments should always be conducted with the assistance and oversight of a qualified intermediary. This will be a financial professional who will be able to act as a mediator between you, the IRS, and the entities involving in the acquisition of the replacement property.
They will be qualified according to IRS definitions, and will likely work with a bank in your area.
Consult the Experts
1031 exchanges are simply not for rookie investors. While they are highly effective, they can only be so when done correctly. Entire industries have developed to deal solely with the bureaucratic minefield that is the 1031.
The regulations for 1031 exchanges may also differ depending on what state you’re in, and what your other income sources are. Always speak to a professional financial advisor well before approaching an exchange of this nature.
You can learn more about how to do a 1031 exchange, or any other methods to maximize your investment returns, by listening to our podcast. You’ll be able to master the rules of finance, wherever you are in the world.