For real estate investors, 1031 exchanges create an opportunity for investors to move from one property to another and provide tax benefits for doing so. With the help of a tax-deferred exchange company, you can sell one or more property and defer the payment of capital gain taxes by acquiring a replacement property. This allows you to keep 100 percent of your money working for you instead of paying about one-third that equity to taxes. However, in a 1031 tax deferred exchange, there are very specific requirements that need to be followed.
Below, we outline what a 1031 tax deferred exchange is and the requirements you must meet in order to successfully conduct this real estate transaction.
Understanding a 1031 Tax Deferred Exchange
1031 real estate transactions are popular for the tax benefits they can provide. Within a 1031 exchange, funds are transferred from one property’s sale to another property’s purchase. This is accomplished through a 1031 exchange intermediary also known as a tax-deferred exchange company, who helps to ensure requirements and the strict timeline are met, while also overseeing all transactions in the exchange. When you find a qualified intermediary, the process can be a lot easier for everyone involved in the transactions.
Types of Properties For 1031 Exchanges
Investors who want to move from one property to another like-kind replacement property use 1031 exchanges to do so. A like-kind property doesn’t mean you must sell a convenience store to buy another convenience store, but that you meet the qualified use requirement for rental or investment purposes (not to be held for sale, like flipping or rehabbing properties). You can exchange out of or into a number of property types, including single family or multi-family, commercial building, retail store, industrial space, and tenant-in-common investments. Discuss the property types you’re interested in with your intermediary to ensure it meets the like-kind requirement.
An Overview of the 1031 Exchange Process
When conducting a 1031 exchange, you have to purchase one or more replacement properties that are equal to or greater in net value than the net value of the old property you sold. All of the net cash proceeds from the sale of the relinquished property must be reinvested in the new property or properties. The debt paid off on the sold property must be replaced by an equal amount on the new property. You can add more cash into the new property, but you can’t pull a case from the sale of the old one. If you do, you will incur capital gain income tax liabilities.
Timeline For 1031 Exchanges
The timeline for a 1031 exchange investment is fairly strict. In order to get the tax deferral benefits, working within the timeline is critical. This timeline includes both time limits for certain parts of the transaction and deadlines that must be met.
Here’s an overview of the timeline that must be followed:
- Investors sell existing property.
- Funds from the sale are transferred to a qualified intermediary to hold for the next sale.
- Upon the sale of that property, investors have 45 days from the sale date to identify the new property to buy and make an offer.
- The intermediary transfers the funds for the new property once the offer has been accepted.
- The 1031 exchange must be finalized and close within 180 days of the sale date of the first property.
1031 Tax Deferred Exchange Rules & Requirements
The transactions involved in the exchange have to be structured properly in order to qualify for the tax deferrals. One of the most important things you can do with a 1031 exchange property is work with a qualified intermediary who will be assigned to both the sale and purchase transactions. Working with an intermediary is actually a requirement of the 1031 exchange, so be sure to find a partial third-party who has no formal relationships to anyone involved in the transaction. In addition to ensuring timelines are met, they will hold the funds and help you find properties that meet the rules of the 1031 exchange.
Within the 1031 exchange timeline, there are a few key rules that need to be met. Each rule has to be adhered to in order to qualify for the tax benefits of the exchange. Here’s a brief overview of the three rules involved, but your 1031 exchange intermediary can go into more detail and help you identify properties that will accomplish your goals:
- Three-Property Rule: The three-property rule allows an investor to identify up to 3 properties that they’ll potentially purchase in the 1031 exchange. The market value of the 3 properties isn’t held to any restrictions in this rule.
- 200% Rule: The 200% rule says that an investor can choose as many potential replacement properties as they like, so long as the cumulative value does not go over 200% of the existing property being sold.
- 95% Rule: The 95% rule states that an investor can identify as many potential properties as they want, as long as they can be acquired at 95% valuation or more.
There are a lot of legal requirements to meet the needs of tax 1031 deferred exchange real estate, so be sure to consult 1031 exchange experts prior to and during your transactions. Each requirement is necessary for the tax deferral benefits, and without following timelines and rules, you could be subjected to penalties.
Find a Partner For Your 1031 Tax Deferred Exchange
When conducting a deal for tax deferred exchange real estate, you need a partner who understands the process and can guide you through the entire thing. This partner, your 1031 exchange intermediary, can ensure you follow the rules and meet the deadlines to benefit from the tax deferral status of the 1031 exchange. Sands Investment Group has extensive 1031 exchange experience, guiding investors just like you through identifying properties and making the transactions required to fulfill the 1031 exchange requirements. We want to help you qualify for all the benefits you are entitled to through a 1031 exchange, so contact our experts today by calling 844.4.SIG.NNN or sending us an email at info@SIGnnn.com.