Many people have no idea what a 1031 exchange is, but hear of it when it comes time to sell off property. This article is intended for those people. I have written this in the simplest way that I can so that it can be understood by all.
First, to understand what a 1031 exchange is, you should understand the purpose behind it. The whole concept behind a 1031 exchange is to defer some taxes (capital gains tax) from the sale of that property, when you plan to invest the profits from that sale directly into another property. People do this so that they do not lose any equity in the transition from one property to another.
Now that you understand the reason for a 1031 exchange let’s talk about the workings of a 1031 exchange. To get started, you will need to hire a professional QI (Qualified Intermediary). It is required by the law. These are companies that are an independent 3rd party whose job it is to make sure that you follow the rules. They also hold the gain from the sale of the original property until you reinvest it into the replacement property.
Next, there are some guidelines about what qualifies for a 1031 exchange. 1031 exchanges involve property. Generally, this would refer to single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities. There are some things that are excluded from 1031 exchanges and you can find those by asking a QI about them.
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.
Keep in mind that this involves the IRS (1031 actually refers to the number of IRS code that this comes from) and as such, of course will have a lot of rules and regulations. You should seek professional consultation on the specifics pertaining to your circumstances. However, there general guidelines will help you to understand some of the basics.
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.
Along with these guidelines, there are some timeline issues that you should be aware of as well. First, you must identify a replacement property by the 45th calendar day from the time of the closing on the old property. (There are even guidelines about how you identify property, but that is for another time) Second, you must close on the replacement property by the 180th calendar day from the time of the closing on the old property. Hopefully this helps everyone understand a little more about 1031 exchanges and how they work. Please consult a professional when you get started doing a 1031 exchange.
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