A 1031 exchange is an exchange of real estate investment properties that allows investors to defer the payment of capital gains tax. This allows real estate investors to sell an investment property and use the funds from the sale to purchase a replacement investment property without being taxed on the capital gains from the sale.
The 1031 Exchange is an important tool for investors looking to maximize and grow the profits from their real estate investments (1). The main reasons why investors take advantage of a 1031 exchange are to:
- Build wealth and improve cash flow by defering the payment of capital gains tax while allowing investors to diversify and consolidate their real estate portfolios.
- Allow investors to switch property types or expand into other real estate markets.
There are requirements and deadlines that investors must comply with in order to qualify for a 1031 exchange. The first deadline is the identification period (2). Within 45 calendar days of the sale date of the relinquished property the investor must “identify the replacement property to be acquired.” The replacement property must be a “like-kind” property. Most real estate properties in the U.S. qualify as “like-kind” property and are defined by the IRS as properties that are of “the same nature or character, even if they differ in grade or quality.”(3). The second deadline is the exchange period. This refers to the 180 calendar day time period in which the investor must acquire (purchase) the replacement property. This deadline’s time period begins once the relinquished property is sold. These deadlines are very strict and there is no wiggle room with either the identification or exchange period.
If you are thinking of doing a 1031 exchange or would like to know more details – the first step is to find a Qualified Intermediary. This is the professional that will facilitate the exchange for the investor. All 1031 exchanges must use a qualified intermediary that meets certain requirements. Below are a few options for Qualified Intermediaries:
On the other hand – if you are a seller or a buyer in a real estate transaction and the other party in the transaction is doing a 1031 exchange in order to buy or sell do not worry. Their participation in the exchange should not affect the transaction. The only difference is that the funds may be coming from or going to escrow from a third party qualified intermediary and not the buyer or seller directly.
Talk to one of our LUVA Realtors today to get started on buying or selling your investment property!