I had no idea what a 1031 exchange was when I first heard of it, but have since learned some more about it. This article is intended to help others who have no idea what a 1031 exchange is, but would like to know. I will do my best to write this in a clear, easy to understand manner.
It is important to understand the purpose behind a 1031 exchange in order to understand it. The point of using 1031 exchange is to defer the immediate taxes on the proceeds gained from the sale of property. This can be done legally if you plan to immediately reinvest those proceeds into another piece of property. The reason you would want to do this is so that you do not lose any portion of the equity you have built up in a property simply because you essentially exchanged one property for another.
Now that you grasp the purpose of a 1031 exchange we can talk about how you accomplish this. To start with, the law requires you to hire a qualified 3rd party to assist you in this by advising you and holding the proceeds from the sale of the current property until you reinvest them in the new property. These people or companies are called a QI – Qualified Intermediary.
There are certain things that will qualify and what will not qualify for a 1031 exchange. 1031 exchanges involve the sell and purchase of property. Most typically, this refers to property like single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities. There are specific exclusions from 1031 exchanges, such as stocks and bonds. You should ask your QI about other exclusions before making any decisions on a 1031 exchange.
Second, the major qualifier is that the properties are of like kind. Like kind refers to the similar nature or characters of properties, not the grade or the quality. They (referring to all properties involved) also must also be held for productive use in trade or business. Another viable option is if they are held for investment purposes.
There are a lot of other specific rules that the IRS has for this kind of exchange and that is likely why they require anyone who does this to use a qualified professional trained in this. However, there are some general guidelines that you should be able to understand and may help guide you in your decisions on your plans for investments if you are looking into this.
1- The value of the replacement property must be equal to or greater than the value than the old property that you are selling. 2- The equity of the replacement property must also be equal to or greater than the value of the old property that you are selling. 3- The debt on the replacement property must be equal to or greater than the debt of the old property that you are selling. 4- ALL of the net proceeds from the old property that you are selling must be used to acquire the replacement property.
There are also some strict timeline guides related to 1031 exchanges. First, the investor must identify the new property within 45 calendar days of the close of the old property. (There are some guidelines about how you identify, but that is a later discussion) Second, the investor must close on the new property within 180 calendar days from the closing date on the old property. I hope that this has helped you understand, in plain English, what a 1031 exchange is. There is a lot more information out there on it and you should consult a professional if/when you get serious about doing this.
As you look around for more info on a 1031 exchange, remember that some people also call it a 1031 Tax Exchange. Always remember to consult a Qualified Intermediary before making any decisions.
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Topics: finance, Real Estate, Real Estate, personal finance