Make the Investment | The 1031 Exchange Rules

What are the 1031 rules?

Taking advantage of a 1031 exchange provides significant tax benefits to investors, but it only works when done properly. There a few factors to pay attention to when you decide to take this investment route. Some questions you may have are: How long do I have to Identify a property? What is a like-kind property?  Do I need a 1031 Exchange Intermediary? So let’s get started, what are the 1031 exchange rules?  Let’s take a quick look at 1031 exchanges.

A “1031” is a mechanism that allows an investor to defer taxes and build wealth over time by deferring the taxes that would normally be due at the time of a traditional sale.  In a 1031, the deferred taxes are invested into a new investment of equal or greater value.  There are strict IRS guidelines that must be followed to conduct a 1031 exchange and reap the benefits.

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    • Like-kind investment.  Rule number one, the investment must be of like-kind whereby both the original and replacement property must have the same nature.   In terms of real estate, any investment property can be exchanged for another investment property, however, any personal property would be excluded from a 1031.  Note:  The property must be located within the US.  Additionally, the replacement property must be of greater or equal value or you will not be able to defer 100% of the capital gains tax.
    • Investment must be under the same ownership entity.  Whether it be an LLC or an individual owner, to qualify for a 1031, the title holder must remain the same.  There cannot be different tax returns/title holders in an exchange.
    • Determine deferred capital gains and depreciation recapture. A significant factor in a 1031 is the depreciation recapture.  Tax rules require that the investor recapture a portion of the gain on the sale that relates to the allowable depreciation over the life of the investment.  Working with an accountant who understands real estate investments will facilitate a more thorough determination of the depreciation.  Further, the recapture must be done at a higher tax rate.
    • Hire a qualified intermediary.  To successfully complete a 1031, the investor must hire a 1031 exchange.  The proceeds from the original sale may not be received by the seller/investor during the exchange period and a qualified intermediary is used to “host” the funds during the exchange.
    • Work with a professional.  As you may have discerned at this point, conducting a 1031 happens quickly with many rules that must be followed.  Although working with a team of professionals is not a true policy, it is a wise path to take.  These professionals will enable a more thorough search and execution of an exchange, allowing the investor to focus on finding the right investments without getting bogged down with the rules of the game.
    • Know your timeline.  There are two parts to the timeline.  First, there is a 45-day identification window.  The investor has 45 calendar days post-closing on the sale of the first property to identify up to three potential properties of like-kind.  This can be challenging to find assets that make sense, so many owners will often start the process well before the original sale takes place.  The second part of the timeline is the 180-day replacement window.  The new property must be purchased within 180 days of the sale of the original investment.

    Avison Young works with clients to establish a solid team of exchange experts.  These exchanges happen quickly, and Avison Young Net Lease can assist you in finding opportunities early to ease the anxiety that can occur once the exchange clock starts ticking.  From the beginning, our team will help you set the right strategies, identify the right investments and execute a swift, easy transaction with the new investment.

    Give us a call to discuss your investments and we can walk you through how to get started.  You can reach us at 202. 508-5987.

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      Traci BidingerMake the Investment | The 1031 Exchange Rules