BiggerPockets

Learning About 1031 Exchanges

A 1031 Exchange is a federal tax code designation that allows property investors to sell one property and buy another without losing money to capital gain tax in the process. In order to qualify for a 1031, an investor must first sell his property and then buy another like kind property within a designated amount of time.

What do I stand to gain from a 1031 Exchange?
The answer is simple: Money. Generally, property sellers are taxed a 20 to 30 percent (or more) capital gain tax. This exchange allows you to put this significant amount of money straight back into an investment, thereby keeping it in your own portfolio.

What exactly is "like kind"?
According to the website 1031ExchangeMadeSimple.com, there are two elements that investors must meet to qualify for like kind purchases:

1. The total purchase price of the replacement like kind property must be equal to or greater than the total net sales price of the relinquished property.

2. Federation of Exchange Accommodators (FEA) requires that all the equity received from the sale of the relinquished real estate property must be used to acquire the replacement like kind property.

If you fit these parameters, chances are a 1031 may be the most savvy move for you. Essentially, this program allows you to increase your investment value. Whereas you would only be able to apply 70 to 80 percent of the proceeds from your sale to a new property under a simple sale, a 1031 allows you to put 100 percent of your sale income back into your investment portfolio.

It's also important to note that you may still qualify for a 1031 even if your new property costs less than the money earned from your previous sale or if all money generated from the sale is not put toward a new property. In such cases, however, a tax penalty will likely occur.

Basic Qualification Rules
Anyone considering a 1031 Exchange should carefully research the U.S. Tax Code and consult with a REALTOR® or financial professional. With this in mind, a few basic rules apply to qualify for a 1031 Exchange:

1. Property must be used as an investment or for business purposes.

2. Sale proceeds must be handled by a qualified intermediary (ideally, someone who deals solely and specifically with 1031 exchanges). It's important to note that this person cannot be your real estate agent, a family member, or someone with whom you have previously done business in a different capacity.

3. The new property must be "subject to an equal or greater amount of debt than the previous property."

4. An identification period must be adhered to. This 45-day timeframe is the time an investor has between the sale of one property and the identification of a potential new property. Note that this can be a list of property and refers to properties the seller wishes to buy. A transaction is not necessary within this timeframe.

5. The exchange period refers to the 180 days following the sale of the initial property which the seller is granted to purchase a new investment property.

Sure, it all sounds like a lot of information. But with the assistance of a qualified professional and some organization, a little effort may well pay off to the tune of an additional 20 to 30 percent profit in your pocket.

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