7 Things to Know About 1031 Exchanges

The popularity of #1031 exchanges continues unabated. Novice and professional investors alike flock to these transactions to eliminate immediate capital gains taxes and reinvest more of their resources.

However, there are many nuances to a 1031 exchange, which is why it is always wise to seek out guidance from a professional experienced with such transactions. Here are a few things you should understand before trying a 1031 yourself.

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. Of course, 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.

Beware The Boot

If you receive any cash during your 1031 exchange, the value is known as “Boot.” Boot is immediately taxable to you as a partial capital gain. You are able to receive boot and still have a valid exchange. It is just important to understand that this will be considered a taxable event in the tax year of your exchange.

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.

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.

Timing Matters

The IRS is very strict when it comes to 1031 exchanges. While they allow you to defer taxes, they also hold you to critical deadlines in order to do so. The first is known as the “45 Day Rule.” This rule requires you to identify your replacement property within 45 days of the sale of your relinquished property. Failing to do so will negate the exchange and taxes will be due.

You Can Designate Multiple Replacement Properties

To make it easier to complete a successful exchange, the IRS permits you to name more than one replacement property. Of course, this is also subject to strict limitations. You can name up to three so long as you close on one of them within the requisite time limitations. Alternatively, you can nominate more than three if they adhere to a valuation requirement (the 200% rule).

Timing Matters (Again!)

In keeping with their strict requirements, the IRS also requires you to close on your replacement property within 180 days of the sale of your relinquished property. The clock starts ticking on the day you sell and runs concurrently with the 45-Day-Rule.

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