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.
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:
- 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.
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.