Understanding the 1031 Exchange

As a real estate investor, understanding the 1031 exchange offers a good option for limiting or even eliminating some of your tax burden when swapping one investment property for another. While most are taxable as sales, exchanges that meet the requirements of 1031 can help you save significantly on your taxes. Even if you profit from each swap, a 1031 exchange allows you to avoid paying taxes until you sell for cash at a later date. Even better, there is no limit to how frequently you can do a 1031 and you can roll the gain from one piece of real estate to another. So, what exactly is a 1031 exchange and how does your transaction qualify?

Meeting Property Requirements

In order to meet the requirements of a 1031 exchange, the property must be an investment property or business property. As such, you cannot switch a primary residence for another home with a 1031 exchange. While certain forms of personal property could once be exchanged with a 1031 exchange, legislation passed in 2017 stipulated that only real estate qualifies for the tax break. This means property such as franchise licenses and aircraft can no longer be exchanged under a 1031 exchange, but interest as a tenant in common in real estate can still qualify.

Closing the Deal

When performing a property exchange as part of a 1031 exchange, it is essential to follow the required timing rules. First, an intermediary must receive the cash as soon as your property is sold. If you receive the cash, you cannot complete a 1031 exchange. In addition, a replacement property must be designated in writing within 45 days of the sale. The IRS allows you to designate up to three properties, but you have to eventually close on one. In some cases, you can designate more than three if they meet certain valuation criteria.

The second timing rule requires you to close on the new property within 180 days after selling the old property. The countdown of the 180 days begins when the sale of your property closes. Therefore, if you designate a replacement property 30 days later, you have 150 days to close on the replacement property. If you have cash left over after the intermediary acquires your replacement property, you will receive this cash at the end of the 180 days. It should be noted, however, that this cash will be taxed as partial sales proceeds from the sale of the property. Similarly, if you have a mortgage on your property, but the mortgage is less on the new property, the difference in mortgages is considered a gain and will be taxed.

As with all tax laws, there are certain exceptions to the rules that must be explored in order to obtain the best tax benefit possible. To learn more about how a 1031 exchange works and to get guidance toward keeping the most money in your pocket, contact Ankor Management today. We will be happy to help you explore all of your available options so you can make the best decisions possible.