What is 1031 exchange?
In a nutshell, 1031 exchange is a direct swap of one business or investment asset for another, but without being liable for any taxes at the time of the exchange. Essentially this means that you can change the form of your investment without cashing out or recognizing a capital gain in the eyes of the IRS. This allows your investment to grow tax deferred.
Are there any limitations to how many times I can do a 1031 exchange?
Currently there are no limits to how many times you can perform a 1031 exchange; rolling over the gain from one piece of investment real estate to another and another and another... you get the picture. This lets you avoid paying tax on your individual profits, letting them build up until you eventually decide to sell for cash. If currently regulations continue then you will only pay one tax at a long term capital gain rate of around 15%.
There are limitations when you exchange for what is referred to as a ‘depreciable property’. Speak to your tax advisor to learn more.
Can I use a 1031 for my personal residence?
The 1031 provision is purely for investment and business properties only, so it does not apply to your primary personal residence. However, you may be able to use it for a vacation home, but there are very strict rules and regulations about if, how and when you can do so. Your tax advisor will be able to give your more information about the guidelines for applying 1031exchange to your vacation property.
The term ‘like-kind’ is extremely broad!
The phrase ‘like-kind’ is used in 1031 exchanges, and you could be forgiven for thinking that you need to exchange a 4-bed townhouse for another 4-bed townhouse, or even a house at all. In fact, the term ‘like-kind’ is very broad and if you wanted to you could swap your 4-bed townhouse for a 1-bed beach condo, a ranch or even just a piece of undeveloped land!
What is a ‘delayed exchange’?
A delayed exchange is also sometimes known as a three-party exchange and exists because it is not always possible to find someone who wants to swap exactly what you need at the right time. The majority of 1031 exchanges are delayed and use a middleman who holds the cash after you have ‘sold’ your property and uses it to ‘purchase’ your replacement property.
Are there any timing rules?
There are two timing rules that need to be strictly adhered to in any 1031 exchange.
1. Within 45 days of the ‘sale’ of your property you must designate replacement property in writing to the intermediary, specifying the property that you wish to purchase. You can designate multiple properties if you come within certain valuation boundaries.
2. You must close on the new property within 6 months of the ‘sale’ of your old one.
Don’t forget about mortgages and debt
It is crucial to consider mortgages or any other loans or debt held against the property that you relinquish, plus any debt against the new property you wish to exchange for. If you don’t receive any cash but your liability reduces that figure will still be treated like cash and taxed as “boot”.
What happens if I receive cash?
If you have any cash left over after the intermediary acquires the replacement property this is known as “boot” and will be taxed as partial sales proceeds from the sale of your property as a capital gain.
This page is just a brief introduction to 1031 exchange. There are many rules and regulations that need to be followed. Contact your tax advisor for the very best up-to-date information and guidance.