What is a 1031 Exchange?
A 1031 Exchange, also known as a “like-kind” exchange is when an owner sells a property and then uses the tax-free profits to buy another investment property. In other words, this exchange allows an investor to sell a property and then use the income from that sale toward the purchase of another investment property that is of similar value (or greater).
1031 Exchanges are a great way to grow and diversify an investment portfolio for those who are looking for a more passive type of investment with consistent income.
Below, Avison Young’s U.S. Capital Markets Net Lease Group has come up with their essential 1031 Exchange tips:
1031 Exchange Tip #1
Adhere to the Strict 1031 Exchange Timeline
Upon the sale of their existing property, the investor has 45 days from the sale date to identify the new property they want to buy in the exchange, and make an offer. Here is a sample guideline on how the exchange could work:
The investor sells their current property.
The funds from that sale are transferred to a qualified intermediary to hold while the investor finds their next investment property.
Upon the sale of the property, the investor has 45 days from the sale date to identify the new property they want to buy in the exchange, AND submit an offer.
The intermediary will then transfer all the funds to execute the purchase once the offer is accepted.
You then have 180 days to finalize and close the exchange from the sale of the initial property.
1031 Exchange Tip #2
Replacement Properties Must Aslo Adhere to Strict Guidelines
Three-Property Rule: The three-property rule allows an investor to identify up to 3 properties that they’ll potentially purchase in the 1031 exchange. The market value of the 3 properties isn’t held to any restrictions in this rule.
200% Rule: The 200% rule says that an investor can choose as many potential replacement properties as they like, so long as the cumulative value does not go over 200% of the existing property being sold.
95% Rule: The 95% rule states that an investor can identify as many potential properties as they want, as long as they can be acquired at 95% valuation or more.
1031 Exchange Tip #3
Find a Reputable 1031 Exchange Intermediary
An effective 1031 exchange intermediary oversees all the transactions involved in a 1031 exchange.
A successful 1031 Exchange always involves a qualified and reputable intermediary. The intermediary will play an integral role in moving and holding funds securely so that capital can be moved from the sale of one property into the investment of another without any tax implications.
In the sale of a property, proceeds from that sale remain taxable unless they’re passed through an intermediary.
1031 Exchange Tip #4
Receipt of Cash and Relief from Debt May Result in a Taxable Gain
Tax laws indicate that the entire like-kind transaction may be disqualified should an investor take control of the cash or other proceeds from the sale of their property before the completion of the 1031 Exchange. Any cash or not like-kind property received at the end of the 1031 Exchange will be taxable to the extent of proceeds that are not like-kind.
1031 Exchange Tip #5
Keep Track of a Property’s Tax Basis
It is vital to track the basis of your properties correctly to comply with Section 1031 tax regulations, as tax payments are deferred not eliminated. The tax due at the time of a taxable sale will be equal to the (Sales Price-Tax Basis)*Capital Gains Rate.