Understanding IRS Code Section Code 1031 can be beneficial for people owning investment properties. Your accountant, facilitator & tax attorney are always your greatest resource for the rules regarding a 1031 exchange since there are many components and rules for qualifications and eligibility. This article will begin to discuss some of the key elements and definition of a 1031 exchange with future discussions to follow.
With a 1031 Exchange if you own an investment property you get to defer paying those taxes if the proceeds are reinvested in a new property which would not be considered a sale but an exchange. This gives the property owner the opportunity to acquire a more desirable property and avoid paying capital gains by leveraging funds that would otherwise be needed to pay capital gains taxes to obtain that new property. Implied by the name a 1031 exchange is a swap of one investment property for a like-kind replacing the traditional sale.
In simplistic terms it allows real estate investors and opportunity for to enhance their wealth at a faster rate of time because large tax bills can be avoided when their proceeds are invested from the property sale into another like property. It can be a great tool to grow for those wanting to grow their portfolio.
There are some suggested beginning steps for a 1031 exchange process that may simplify and validate your desired 1031 exchange process:
a. Finding a qualified intermediary(principal in the sale of the relinquished property & the replacement property for the tax payer.)
b. Retain the services of state-licensed tax counsel or certified public accountant.
c. Establish and Identify the property to purchase prior to listing the property or begin when the property is listed.
Here are some of the regulations and rules for a 1031 exchange to be valid:
- Like-Kind Property Rules
- The Three – rule Property Up to three properties regardless of their market value. All of the identified properties are not required to be purchased to satisfy the exchange; only the amount needed to satisfy the requirement.
- The 200% rule-The market value of the replacement properties combined can’t be more than 200% of the relinquished property.
- 95% Rule-95% of the properties identified must be purchases or the entire exchange is invalid. An exception is if you close on a property within a 45 day period still qualifies for an exchange.
- 45 day time limit to find an exchange property- You have 45 days to identify the new property/properties from selling of the original property. These time-lines are strict.
- 180 days to complete the transfer- The investor has 180 days from the date the original property was sold to close on the replacement property.
- Personal properties do not qualify and 1031 exchange properties- A generalized rule of thumb is that you can’t use a 1031 exchange if you lived in it for at least 2 of the past 5 years. Vacation homes and second homes usually don’t count either.(Paragraph 280 section 1031 outlines the usage test)
- Flip/Fix Properties not valid, however- This is a category recognized as a property held for sale. For qualifications of a 1031 exchange the new and old properties have to be held as an investment or used in a trade or business. It may be able to count if the property is rented out for a few months before selling to an investor but suggested consultation with a certified tax accountant or counsel to see if this option would be valid in your circumstance for a 1031 exchange.
If anyone thinks that they are qualified or would like some additional information on a 1031 exchange as an option opportunity to building their portfolio and like to consider listing their investment property for an exchange of another like property please feel free to contact me here.
Information for this article gather from the tax code 1031; Wikipedia; broker and real estate continuing education. information in this article deemed reliable but not guaranteed. Be advised determine qualification with certified accountant; tax attorney; facilitator before moving forward with a 1031 exchange.
Charles Provenzano, Jr.
CEO/Emporio Provatta Home
Global Advisor/Vista Sotheby’s International Realty/DRE # 0279236
Honored Inductee 2020 Who’s Who in America/recognized for contribution
to real estate and design
Coastal Expert Long Beach through Orange County, CA