Breaking Down a 1031 Exchange

     A 1031 exchange allows you to transfer profits from one investment property to another without paying capital gains tax. This lets you grow your portfolio and increase your passive income with a huge tax break.

HOW DOES A 1031 EXCHANGE WORK?

    When you sell a commercial or residential property at a gain, the IRS wants to tax that gain. This capital gains tax will take about 15% of your profits directly from your pocket. For like-kind property, a 1031 exchange allows you to defer this capital gains tax and reinvest that money into a different like-kind commercial or residential property.

     The money goes straight from the first property to the next property, through a qualified intermediary, without you ever having access to the funds. If you did gain access to them at some point, it would be considered taxable by the government.

HOW DO I QUALIFY FOR A 1031 EXCHANGE?

     A 1031 Exchange is pretty much open to anyone investing in real estate, but there are a few stipulations that you should keep in mind. 

     - IT MUST BE LISTED UNDER THE SAME OWNER

     This may not seem like a big deal at first, but it can be problematic in certain situations. For example, if you purchased the first property as an individual and have since created an LLC for operation, the title must still list you as an individual. This goes for name changes and marriages as well. If you owned the first property under your maiden name and have been recently married, the second property must still be listed under your maiden name.

     - YOU MUST PROVE INVESTMENT INTENT

     A 1031 seems very enticing to someone flipping properties, but, unfortunately, it may not apply to them. In order to qualify for a 1031 exchange, you must prove that your original intent was to hold and gain passive income from the property and that the property isn’t a personal residence.

     - THE 1031 EXCHANGE TIMELINE

     In order to keep investments moving, the IRS enforces a strict timeline for all 1031 exchange cases.

     - WITHIN 45 DAYS AFTER CLOSING

     You must identify and submit up to three potential properties to the IRS once you’ve decided to purse a 1031 exchange. This must be done before 45 days after closing the sale of your property. Once you’ve submitted your properties, you may only choose one of those three, so choose carefully. Since 45 days is so short in the world of real estate, we recommend scoping out potential properties before even putting yours on the market.

     - WITHIN 180 DAYS AFTER CLOSING

     180 days after your sale closes, you must have closed and owned your new property or you will lose your 1031 exchange option. The IRS is strict about this and doesn’t offer extensions, so it may be smart for you to even have your new property under contract before closing on your own property’s sale. This gives you plenty of time to close on your new property in this short window.
     If you are participating in a 1031 Exchange, you may benefit from a cost segregation study on the “step-up” (ask your CPA for the new basis on the new purchase). 

     Talk to your CPA or financial advisor for more information about using a 1031 exchange.