For a new investor, a 1031 exchange may sound simple and interesting. However, there is more to it. Like any other ways to productively hold investments, there are guidelines, timelines, as well as standards in place. To know more about 1031 exchange services, keep reading.
What Is a 1031 Exchange?
A 1031 exchange is a transaction wherein a taxpayer is permitted to exchange an investment property for another by deferring tax emanating from the sale. It is authorized by Section 1031 of the Internal Revenue Code. Section 1031, also called Starker Loophole or like-kind exchanges, provides tax deferment on qualifying exchanges of like-kind real estate.
What Are the Requirements for a 1031 Exchange?
The exchanger or investor should adhere to the 45- or 180-day guideline for exchange. From the time he sells the property, he has 45 days to find a property that is at least equal to the value of such property. Once a property is chosen, he has 180 days from the time he has sold his property to buy the identified (like-kind) property.
2. Like-Kind Properties
A like-kind property is a similar type of property as the one being exchanged. If an exchanger sells a residential building, he can find a commercial building as a like-kind property. A farmland can also be exchanged for an industrial land or an industrial building.
3. Relinquished Property and Replacement Property
The property that was sold for investment (relinquished) and the one bought (replacement) should be both held for investment or business-related purposes. Using your residence as a relinquished property is not allowed. Conversely, selling a property to buy a home is prohibited.
4. Equal Value of Properties
A property that is sold for $500,000, for instance, where half of it is equity and the other half as debt can be matched by a new property worth at least $500,000. The exchanger also has to use up all the equity and replace the debt to defer the full value of the capital gains taxes.
5. Constructive Receipt
An exchanger may face the possibility of not receiving any cash from a sale. This is called a constructive receipt. This leads to a taxable event. To prevent this from happening, the exchanger must utilize a qualified intermediary to hold the proceeds of the sale and purchase the replacement property for him. The qualified intermediary must be an independent third party.
Risks in 1031 exchanges are common. To know the list of risks in 1031 transactions, it is advisable to get a hold of a private placement memorandum (PPM). It is also wise to discuss the risks with your financial representatives to avoid potential losses or issues when transacting with a 1031.
There are many ways to benefit from real estate properties. You can sell or buy one but have to face taxes. Or you can make an exchange to defer taxes. A 1031 exchange is a good investment option when one is trying to defer capital gains taxes. It offers an investor a chance to sell a property with the least possible cost or related risks.