Why Do Investors Like the 1031 Exchange?
Why Do Investors Like the 1031 Exchange?
Real estate investment can be financially rewarding. One possible way investors can utilize the existing tax laws to their advantage is through a 1031 exchange. With a little due diligence, a 1031 exchange can help investors pay little or no capital gains tax at the time of the transaction. Of course the transaction must meet all the 1031 requirements in addiition to purchasing the new property within the established timeframe.
Investors who are eligible can grow their investment, tax deferred. A 1031 exchange can be performed as many times as desired. A profit would need to be declared when properties are sold for cash at a future time. Investors should note that complications may arise and tax laws are subject to change. Therefore, it is best to speak with a trusted professional before selling and buying different investment properties. Understand more about how the 1031 exchange works and why real estate investors are using it to grow their wealth today.
Basics of the 1031 Tax-Deferred Exchange
Investors may not understand the purpose of the 1031 exchange, wanting to know more about how they may defer the payment of capital gains taxes. The 1031 tax-deferred exchange allows an individual to defer the tax consequences of the sale of an investment property by selling the original property and investing in another. Both properties must be used for investment, trade or a business. The other property purchased need to be such that it is a qualifying type of real estate. A commercial property can be swapped for a duplex, or an apartment building could be bought after the sale of a piece of land.
The average homeowner would not be eligible for a 1031 exchange, unless they are venturing into real estate investment. Investors of commercial, residential, business and other types of real estate would want to consider the potential of the 1031 exchange, as they would be able to hold off on having the gain or loss on an exchange recognized with this legal process. A benefit for investors is that any profit made during the sale of the original property and acquisition of a new like-kind property would be able to be reinvested.
Prepare to Move Fast
Investors must adhere to strict guidelines to benefit from the 1031 exchange. After the sale of the property, only a 45-day period is given for the individual to identify a desired property valued of the same or greater value. After this, the investor is given 135 more days or 180 days from the date the original property was sold in which to buy the new property. It may be useful to have one or more properties in mind before initiating the sale of the original real estate to swiftly make progress on investigating and closing on a like-kind property.
Use All Existing Equity
With the 1031 exchange, investors are encouraged to use the existing equity and debt and purchase a property of equal value or more. Investors cannot sell the original investment property and then buy real estate of lesser value. The same equity and debt must be transferred to the new property to defer all the capital gain taxes. An investor may do a partial exchange or “boot”. In this way they may not use the entire sales proceeds in the exchange but will need to pay capital gains taxes arising from the difference. They may also add more proceeds or debt with the exchange.
Facilitate the Transaction with a Qualified Intermediary
Unlike when a Brooklyn Park homeowner would sell their primary residence and buy a new one, the terms of a 1031 exchange does not allow an investor to sell property and receive cash directly. Rather, they have to work with a QI or Qualified Intermediary to assist with the transaction. This independent 3rd party has the responsibility of holding sales proceeds and purchasing replacement property on the behalf of the exchanger. An investor should be making offers on one or more properties with the intent to close. This would follow the good-faith covenant established with a contract.
Learn About Any Restrictions
The 1031 exchange is not always a straightforward process. Issues may occur when a property that has depreciated is exchanged, such as the depreciation being recaptured as ordinary income and eligible to taxation. Some personal property used to qualify for a 1031 exchange, but this is no longer possible. A narrow loophole still exists permitting investors in to swap vacation homes and be eligible for a 1031.
It is necessary to stay abreast of new tax law changes and how they may apply to the selling and buying of real estate properties for investment. Novice and veteran investors may want to seek professional advice on whether they can benefit from a 1031 exchange with their unique set of circumstances.