Five Things to Know Before Conducting a 1031 Exchange

Many real estate investors would like to trade their current property for something else. Perhaps they are relocating and don’t want the hassle of managing investment property from across the country. Maybe they are getting close to retirement and don’t see themselves fielding 3:00 a.m. phone calls from tenants very much longer. Whatever the reason, selling investment property happens with regularity.

And for those investors who want to avoid capital gains tax liability, a #1031 exchange is a solid way to keep the tax man at bay, while staying in the investment property game. But before you embark on what could turn out to be a challenging tax-deferral journey, you must know the basics of how an exchange works.

Not For Personal Use

While it may be tempting to consider trading up your primary residence and avoiding capital gains liability, a 1031 is only available for property held for business or investment use.

There Are Some Exceptions To The Personal Use Prohibition

Like most things in the IRS code, there are exceptions to the rule. While generally, personal residences don’t qualify, you may be able to successfully exchange personal property such as your interest in a Tenancy-In-Common or a piece of artwork.

Exchanged Property Must Be “Like-Kind”

This is an area that sometimes confuses new investors. The term “like-kind” doesn’t mean “exactly the same” but merely that the exchanged properties be similar in use and scope. While the IRS rules are liberal, there are many pitfalls for the unwary.

Exchange Your Vacation Home With Caution

Although primary personal residences are excluded from 1031 exchanges, 8under certain circumstances you can successfully exchange a second home. To effectively do so, the property must be 100% a rental property and your personal use cannot exceed 15 days per year or 10% of the number of days during the year for which the dwelling is rented out at fair market value.

All Exchanges Don’t Happen Simultaneously

One of the key benefits is that you can sell your current property and have up to six months to close on the acquisition of the “like-kind” replacement property. This is known as a delayed exchange. When you want to complete such an exchange, you will need the help of a qualified intermediary – the person who will hold the sale proceeds from the relinquished property and then “purchase” the replacement property for you.

To learn more about 1031 exchanges or our qualified intermediary and replacement property locator services, please visit our website.