Understanding the 1031 exchange
When it comes to investing, part of the what we like to see is capital gains. We buy for $10 and sell for $20. What we dislike seeing is capital gains taxes. With most investments there is not much we can do about taxes, but this is not always the case with Real Estate.
By using a 1031 Exchange we can defer paying any taxes on the $10 profit aka capital gain, we made on the sale of our property. Here are the basics of how it works.
Does Your Property Qualify?
For your property to qualify it must be held for business or investment use. No personal residences here. Fix and flips typically take place in too short a time frame to qualify, but if you rent it out for a period of time, it should qualify as a long-term investment property. Always confirm the details with your accountant or tax advisor.
The second part involves the property you wish to purchase. Again it must be for investment purposes only, no personal residences. These qualified properties include office buildings, single family homes, and even undeveloped land.
Do I need a Qualified Intermediary (QI)
Yes. According to 1031 exchange guidelines, you need a third party to accommodate the sale, and hold the pay-out from the current held property. The QI also buys the replacement property on your behalf before deeding it to you. Only engage in 1031 exchanges with people and companies you trust.
What are the deadlines for 1031 exchanges?
Once the sale takes place you have 45 calendar days to identify your replacement. The rules allow for up to 3. The catch is one of the three must be the one you close on. As you can see with these short timelines you must plan ahead whenever possible.
Ideally with some good planning you have your replacement property under contract the day your currently held property closes and the 45 day window starts.
Your second deadline starts from the day you close on the sale of your currently held property. From that time you have 180 days to close on the selected replacement property. And yes both time limits are activated on the same day. There are no exceptions or extensions granted. The only exception is your tax due date. If your taxes are due before 180 days, the sooner date is your new deadline.
Are 1031 Exchanges worth it?
100% yes! The impact of deferring capital gains taxes is a powerful compounding tool. We’re talking real life monopoly money growth here. This has an almost unimaginable boost in compounded investment return. In theory you can keep these exchanges going until the day you die. With some proper planning you can avoid paying taxes on your property investments your entire life, and then pass the final value on to your heirs free from all the taxes you would have paid in your lifetime. That is a pretty amazing deal.
If you need 1031 exchange help, lets start planning the process together.
Contact us by filling out our 1031 form here.