1031 Exchange Rules

You have an investment property. And its value has increased slowly and steadily over your years of ownership. And whether this investment is for your retirement, your kids’ inheritance, or even just a rainy day, its worth has grown, but maybe not as much as you had hoped. What if you could make this investment work harder towards increasing your wealth? Maybe you are looking for a property that has better prospects on return? Or you would like to diversify your assets? Or you are estate planning and considering dividing a single property into multiple investment properties? A 1031 tax exchange is a real estate investment tool that can help you achieve these goals, as long as a few important things are kept in mind.

Also known as a like-kind exchange, a 1031 exchange enables investors to avoid paying capital gains taxes when selling an investment property by reinvesting the profits from the sale into a property or properties of similar or greater value. This tax deferral offers the main benefit to a 1031 exchange, in that more of your capital is available to use towards the replacement property. In essence, money that would have gone directly to the government is now able to be used in the purchase of your next investment. With a successful 1031 exchange, more of your money is working for YOU, helping to build your worth and the legacy you pass to your heirs.

Main Requirements for a 1031 Exchange

While the growth possibilities of a 1031 exchange seem too good to be true, with planning and the help of experts, they can be achieved. There are important rules that must be followed to successfully execute this key real estate investment tool:

·       Hire a qualified intermediary to document the transaction and securely hold funds.

·       Another investment property must be purchased as the replacement property.

·       The replacement property needs to be of equal or greater value.

·       All proceeds of the sale must be directly reinvested into the replacement property.

·       The same person must be both title holder and taxpayer.

·       The replacement investment property must be identified within 45 days of the initial property’s sale.

·       Purchase of the replacement property must occur within 180 days.

The 45-Day Rule

Under Section 1031 of the United States Internal Revenue Code, from which the 1031 exchange receives its name, capital gains taxes can be deferred when selling property and directly reinvesting into a like-kind property. At no time can the sale proceeds be received by the seller, or they become taxable, and the exchange is unsuccessful. To keep a 1031 transaction on track, once your property sells, a qualified intermediary holds the funds involved until they can be transferred to the replacement property’s seller. The replacement property must be identified in writing to the Intermediary within 45 days of your initial property’s sale. And the IRS does say that three properties can be designated in the exchange, and more if they fall within certain valuation requirements. But the 45-Day Rule is crucial to adhere to, or you become liable for capital gains taxes.

The 180-Day Rule

Another time-sensitive regulation that can have damaging effects on the 1031 exchange if not adhered to, the 180-Day rule requires that you close on the replacement property within 180 days of the sale of your initial property. If this does not happen, the 1031 exchange is unsuccessful, and you are liable for capital gains taxes on the proceeds from your investment property’s sale. Note: if you are doing a Reverse Exchange, where you purchase a replacement property before the sale of your initial property, the same 45- and 180-day timeframes would apply.

With all of the rules and requirements surrounding a 1031 exchange, this real estate investment initiative may seem out of reach for the average person. But with the expert help of a knowledgeable, qualified intermediary, you can be on your way toward your wealth-growth goals in no time. Or really, even in just 180 days!

Reach Out!

Southern California Exchange Services excels at helping clients strategize and optimize their real estate investments through 1031 tax-deferred exchanges nationwide. We are committed to helping our clients pursue and realize their financial goals and are ready to help you, too. If you have any questions about the 1031 Tax Exchange or are ready to take the first step, please visit our website or reach out to us at megan@sces1031.com or 805-738-2599. We look forward to hearing from you!