1031 Exchange Investment

How Can A 1031 Exchange Investment Work For You?

Many of our clients ask why they should take advantage of a 1031 exchange investment. One of the most popular reasons why people invest in real estate are because of the tax benefits and 1031 exchange investments can offer exceptional value on your investment. Instead of spending your money and paying the government, you use your money to earn more money.

If this is your first time exploring the world of real estate, you will want to consider talking with a Avison Young net lease professional for advice about 1031 exchange investments. We can provide information, answer questions and help guide you through a 1031 exchange investment process. When planning for your exchange, there are many variables you will want to consider before making that final leap.

What Is an Exchange Investment?

When you sell property and make a profit, the Internal Revenue Service (IRS) requires you to pay a capital gains tax on the profit you made from the sale. However, there is a provision in the U.S. tax code, IRC Section 1031, which allows you to postpone paying those capital gain taxes if you take the profits you earned from selling that piece of property and reinvest them by purchasing a similar investment property. A 1031 exchange investment is named after this IRS rule.

In order to qualify as a 1031 exchange investment, the property you sell and the property you purchase must be for either business or investment purposes. Real estate that is purchased for personal use – such as your primary residence or vacation homes – do not qualify for a 1031 exchange investment. Under the IRS rules, the property must also be “like-kind,” meaning the two properties must be the same character, class, or nature.

“Like-Kind” Exchanges

A property that is being held for use in a trade, business or investment can be swapped for a like-kind property. When the term “like-kind” is used, it refers to the essence of an investment, not that you must exchange the same kind of property for another. For example, you can exchange a house for an apartment, condominium, office or open land.

However, the rules do allow you to exchange one type of investment property for another. For example, if you sell a rental house, you do not necessarily need to purchase another rental house. Instead of a house, your second purchase may be an office building that you will rent to a business.

What You Cannot Exchange

A person is not permitted to swap notes, stockes, certificates of trust, bonds or partnership shares. You are also not able to exchange an investment property for stock-in-trade, a personal home, or property outside of the country. If an investor was to purchase a property that needs fixing up and sells once the improvements are made, then the property can be used for stock in trade and is not able to be exchanged.

Who Qualifies for a 1031 Exchange Investment?

Under IRS rules, the following entities may set up a 1031 exchange investment:

  • Individual;
  • General or limited partnerships;
  • Limited liability companies;
  • C corporations;
  • S corporations; and
  • Other taxpaying entities

Time Constraints on 1031 Exchange Investments

In order to take advantage of this investment opportunity, you must identify the replacement property within 45 days of the sale of the first property. This identification must be in writing and delivered to the party selling the property, their representative, or an intermediary. When ourAvison Young net lease team is overseeing your 1031 exchange investment, we can act as a qualified intermediary to the identification.

The final sale must take place within 180 days of the sale of the first property, or before the due date of your tax return for the tax year the sale of the first property took place – whichever comes first.

Time Requirements

Within 45 days after the closing of the relinquished property, an investor must designate properties that he or she plans to collect in exchange. Additionally, the investor has 180 days post closing date of the relinquished property to seal the deal on a new property. The investor can choose up to three possible properties and then must acquire one of them by the end of the 180 day term.

How a 1031 Exchange Investment Works

A 1031 exchange investment takes its name from the Internal Revenue Service’s 1031 Code. This is an investment strategy that allows an individual to defer paying capital gains taxes when they sell an investment property if they use that profit to purchase a similar type of investment property. This can be advantageous for investors who wish to minimize their tax obligations while at the same time increasing the value of their investment. Alternately, the investor may wish to move their investment location by selling one property and purchasing another in their preferred location. Our net lease 1031 exchange team has guided many investors during the process of making a 1031 exchange investment, and we can help you too. Call us to request a free consultation during which we can explain your investment options as they reflect your portfolio needs and priorities.

Though an investor could certainly exchange a property with another’s investment property, a 1031 exchange investment is usually not this literal. More often than not, the process will occur along these lines:

  1. An investor sells a property.
  2. The proceeds from that sale are held by a middleman.
  3. Those funds are used to buy the replacement investment property. It is permissible for the replacement property to cost more than the value of the original property.
  4. This is a three-party financial investment exchange that is treated by the Internal Revenue Service as a swap.

Ideal Circumstances for a 1031 Exchange Investment

Capital gains tax may be collectable after the sale of an investment property if it is not a 1031 exchange investment. Under some circumstances, selling an investment may be costlier than any profits earned by that investment. If you own a rental property that has significantly increased in value since the time you purchased it, rather than sell it and have to pay substantial capital gains tax, you could instead take advantage of a 1031 exchange investment to avoid paying taxes on your profit.

1031 Exchange Investment Rules

There are a number of rules that an investor must follow when engaged in a 1031 exchange investment or else they become vulnerable to tax obligations such as capital gains taxes. Your advisor at Avison Young can provide you with the information you need to avoid such taxes. The following is one of the primary rules associated with a 1031 exchange investment, which is that the property exchange must be like-kind:

  • This means that the replacement property and the original property must be of the same “nature or character” though they may vary in terms of quality. As an example, you can’t replace stocks with a commercial building because they’re not the same kind of asset.
  • As far as what kind of real estate property can be involved in the exchange, as long as the property is commercial rather than personal property, it will probably qualify. Your Avison Young net lease advisor will make sure that the exchange of properties will fulfill the requirements.

Choosing a 1031 Exchange Investment Facilitator

When making preparations for an exchange, you will want to reach out to an exchange facilitation company. You can browse online for facilitators in your area or ask for recommendations through your attorney or real estate agent. Keep in mind that escrow companies, real estate agents and attorneys should not be used to fulfill the role of a facilitator.

Replacement Property Restraints

The investor who participates in a 1031 exchange investment must provide a detailed description of what kind of replacement property they are looking for by the end of the 45th day, post relinquishing of the initial property. If the investor wishes to designate more than a single property, they must follow one of these listed guidelines:

  1. Designate more than three properties with a cumulative value that does not surpass 200% of the relinquished property market value.
  2. Designate three properties of any value with a serious intend to seal the deal on at least one property.
  3. Designate more than three properties with a cumulative value that surpasses 200% of the relinquished property (with the understanding that 95% of the market value for all properties designated must be obtained).

Call Us Today

Our team of committed and knowledgeable professionals at Avison Young’s net lease team can assist you in finding out more about the stages within a 1031 exchange investment procedure. We will take your needs into consideration before scouring the net lease market to find your ideal investment

To learn more about how a 1031 exchange investment can help your money earn money, just request a consultation with one of our advisors.  Call Avison Young’s Net Lease Group today!

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