For those who do not understand what a 1031 exchange is, but you have heard of it and would like to know what it is now is your chance. Also, I will do my best to explain it in very simple terms so that no matter your background you will be able to understand it and how you can benefit from it.
Before you can understand how a 1031 exchange works, you should first understand why they exist. They exist so that people can avoid losing money in form of capital gains tax when they sell one property with the intent to reinvest the proceeds immediately. A 1031 exchange makes it possible to defer the capital gains taxes. The term 1031 actually comes from the IRS code. The reason this was created was to encourage people to continue to reinvest their profits, thus helping the economy.
So now that you understand the purpose, you should understand a little bit about how it works. First, you are required by law to have what is called a QI. This is a 3rd party that is independent and serves as a Qualified Intermediary (hence QI). They are there to hold the profits from the sale of the first property that you sale until you invest it into another property(s).
Next, there are some guidelines about what qualifies for a 1031 exchange. 1031 exchanges involve property. Generally, this would refer to single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities. There are some things that are excluded from 1031 exchanges and you can find those by asking a QI about them.
Second, the move from one property to another has to be of like kind. This does not refer to the condition or value of the properties, but rather that they are similar in character or nature. They (referring to all properties involved) must also be held for productive use in trade or business or held for investment purposes.
Keep in mind that this involves the IRS (1031 actually refers to the number of IRS code that this comes from) and as such, of course will have a lot of rules and regulations. You should seek professional consultation on the specifics pertaining to your circumstances. However, there general guidelines will help you to understand some of the basics.
1- The value of the new property must be of equal or greater value than the one you are selling. 2- The equity of the new property must also be of equal or greater value than the one you are selling. 3- The debt on the new property must be equal or greater to the debt on the property that you are selling. 4- ALL of the net profits from the property that you are selling must be used to acquire the new property.
There are also some timeline issues that you will want to be aware of. First, in order to successfully qualify for a 1031 exchange, you will need to identify a new property by the 45th calendar day from the time of the closing on the relinquished property. (There are guidelines about that too – see a professional) Second, you need to close on the new property by the 180th calendar day from the time of the closing on the relinquished property. Hopefully this helps. Please call a professional when you are getting ready to consider a 1031 exchange.
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