1031 Exchange Questions Answered

A wealth-growth strategy employed by savvy real estate investors, the 1031 Tax Deferred Exchange puts extra money into the investor’s portfolio by allowing them to defer payment of capital gains from the sale of a property by immediately investing them into another. With full profits going back into the replacement property, the investor is able to purchase property or properties with more value than the original, and feasibly increase their holdings. It is a tactic that can be employed over and over to grow wealth, as long as certain rules are followed. The 1031 Exchange can be tricky, with very specific timelines and regulations. And while we ultimately recommend consulting an expert for the actual transaction, we want to answer some commonly asked 1031 tax exchange questions.

Can You Live In a 1031 Exchange Property?

No… and yes. A 1031 exchange cannot immediately and directly become a personal residence. One of the strict rules of a 1031 exchange is that the involved assets must be investment properties. Personal usage of the replacement property cannot exceed either 14 days or 10 percent of the total number of days the asset was rented during a 12-month period. However, after reporting the property for at least 2 tax years from the 1031 exchange, the property can become a primary residence- just make sure you follow the Internal Revenue Service’s specific rules for doing so.

Do You Have to Use a Qualified Intermediary for a 1031 Exchange?

This answer is a definite yes! In this swap of two investment properties, a Qualified Intermediary is an independent party who facilitates the entire complicated process. It is highly unlikely that the sale and purchase of the relinquished and replacement properties happen at exactly the same time. And once any money from the sale of the initial property hits your account, it is taxable and the exchange cannot occur. So, as an unrelated entity to the investor, the Qualified Intermediary holds the proceeds of the initial sale in an escrow account until they can be applied to the replacement property or properties. The intermediary is also an expert in IRC §1031 and the strict timeline, and it is their job to keep the 1031 exchange on track and in compliance in order to ensure a successful transaction. Not only do you have to use a Qualified Intermediary, but you will WANT to.

What are the Rules of a 1031 Exchange?

While the 1031 Exchange process is full of regulations and tax code nuances, there are some basic requirements to keep in mind:

·       Both the initial and the replacement properties must be investment assets.

·       The replacement property must be equal to or greater in value than the initial property sold.

·       All net proceeds from the sale of the relinquished property must be invested into the replacement property to avoid taxation.

·       The investor’s intent to exchange the property must be disclosed on all real estate contracts, and with proper verbiage. If this step is not completed, the result will be a non-recognized exchange and the investor will be responsible for taxes incurred on the sale of the property.

·       The 1031 Exchange timeline must be met.

What does a 1031 Exchange Timeline Look Like?

A 1031 Exchange has a specifically defined schedule that must be followed. Thankfully, your Qualified Intermediary will keep you on track, but we’ll give you an idea of a typical timeline:

·       Day 1: This is the date that the sale of your initial property is completed. The Qualified Intermediary receives the proceeds from the sale transaction, and the clock starts ticking.

·       Day 45: You have until the 45th day after the sale of your initial property to identify a replacement property or multiple properties.

·       Day 180: Within 180 days of the sale of your initial property, the purchase of your replacement property must be completed. During this time, the qualified intermediary transfers the proceeds from the sale of your relinquished property to the seller of the replacement property.

As with every real estate transaction, the rules are detailed and there are many. But the 1031 Tax Deferred Exchange offers great value over the long term to those who use the strategy wisely, and with the help of a Qualified Intermediary.

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 Deferred 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!