1031 Exchange

Exchanging property through a 1031 exchange can save you capital gains taxes. If you own investment property, you can sell it and invest the proceeds in a new one without paying taxes! But there are strict IRS rules to follow, so using a qualified intermediary is a must.

What is a 1031 Exchange?

Also called a Starker Exchange, this tax deferment is like getting an interest free loan on the tax dollars that you would have ordinarily used to pay from the cash sale of your investment property. You can retain more equity in the property this way, and it helps you trade up to more valuable real estate each time you do a 1031 exchange. You can defer the capital gains taxes if you use all of the exchange funds to purchase like kind investment property.

When you sell real estate that is held for investment purposes, you are eligible to do this type of exchange. Other uses that qualify are real estate for income production and business use. You can't defer taxes on your own personal home, though, the deferment is reserved for investment properties and not property used for your own personal use.

You must also exchange like property with like property. For real estate means real property must be exchanged with other real property, but not necessarily land for land or apartments for apartments. You can exchange one property for many, or purchase one home from the sale of several with 1031 exchanges. Any proceeds leftover that you don't use for the new purchase get taxed as a cash sale.

Help With 1031 Exchanges

Before you sell your property, locate an intermediary, also known as an accommodator. This company or person is a neutral party that holds the proceeds from your sale, then uses the funds to purchase the new property and transfers the title to you. Because the IRS code is so complex, it really pays to hire somebody who is qualified and experienced with 1031 exchanges.

Before you put your property under contract, identify a replacement property. You have 45 days from closing on the sold real estate to identify up to three replacements. You have to send the list to your intermediary in writing. Closing dates for the new property or properties must take place within 180 days of the closing on the property you sold. That gives you up to six months to pay for your new property without having to pay taxes on the profit!

Be sure to have the wording on your contracts specify your intent to do a 1031 exchange. That is where an intermediary can be helpful, since they sometimes offer additional services. Or, your real estate agent can help you with this. Be sure to send a copy of the sales contracts to your intermediary, along with any other information they might need.

The Importance of Keeping in Touch with Intermediaries

Intermediaries take care of most of the paperwork with 1031 exchanges, so they really do make your life easier. However, since you do have six months to complete the transactions, be sure to keep in touch with your intermediary. Let them know where your deals stand at all times so they can process your transactions properly. After all, they are helping you to save thousands of dollars on your taxes!