What is a 1031 Exchange? A 1031 Exchange (also called a Like-Kind Exchange) is a swap of one business or investment asset for another with no tax or little tax due at the time of the exchange. But you don’t have to be a tax nerd who is able to recite Internal Revenue Code Sections in order to have a clear grasp of what a 1031 Exchange entails. Although there are some complexities behind a 1031 Exchange it really can be a simple process if you educate yourself and are completely aware of what you are getting into. If you are considering doing a 1031 Exchange, or if you’re just curious about this type of investment option here are 10 important facts you should know.
1. A 1031 Is Only For Investment/Business Property – A 1031 is NOT for personal use. You cannot swap your primary residence for another home. There are some ways that you can swap a 1031 for a vacation home but this loophole is not as broad as it used to be. For further details about this option see #10 or contact a tax attorney.
2. Some Personal Property Qualifies – Most 1031 Exchanges are for real estate. However, some exchanges of personal property (like a painting) do qualify. However, exchanges of corporate stock or partnership interests don’t qualify. On the other hand, interests as a tenant in common in real estate do.
3. “Like-Kind” Is Broad – Although the term seems that you could only do an exchange for a single- family home for another single-family home, or a warehouse for another warehouse, this is not the case. You can exchange an apartment building for raw land, or a ranch for a strip mall. The rules are surprisingly liberal and less rigid. You can even exchange one business for another.
4. A “Delayed” Exchange Is An Option – Theoretically, an exchange involves a simple swap of one property for another between two people. But the odds of finding someone with the exact property you want who wants the exact property you have a very slim. For this reason the majority of exchanges are delayed, three party, or Like-Kind exchanges. For delayed exchanges a middle-man is needed to hold the cash after you sell your property and uses it to buy the replacement property for you. This three party exchange is considered a swap.
5. You Must Identify Your Replacement Property Within 45 Days – There are two rules in regards to timing when dealing with a 1031 Exchange. The first relates to the designation of the replacement property. Once you sell your property the intermediary will receive the cash. If you directly receive the cash then it cancels the 1031 treatment. Also, within 45 days of the sale of your property you must designate the replacement property in writing to the intermediary specifying the property you want to acquire.
6. You May Designate Multiple Replacement Properties – According to the IRS, you can designate three properties as the replacement property as long as you eventually close on one of them. Alternatively, you can designate more properties if you come within certain valuation tests. For example, you can designate an unlimited amount of replacement properties as long as the fair market value of all the replacement properties does not exceed 200% of the aggregate fair market value of all the exchanged properties.
7. You Must Close Within 6 Months – The second timing rule in a delayed exchange relates to closing. You must close on the new property within 180 days of the sale of the original property. Be advised that the two time periods run concurrently. That means you start counting the days once your original property closes. If you designate a replacement property 45 days later, then you’ll have 135 days left to close on the replacement property.
8. Cash Is Taxed – If you have cash left over after the intermediary acquires the replacement property they will pay it to you at the end of the 180 days. That cash will be taxed as partial sales proceeds from the sale of your property, generally as a capital gain.
9. You Need To Consider Differences In Mortgages And Debt – A lot of people get into tax trouble when they fail to consider the difference in the amount of the loan on their old property and the amount of the loan on the new property. If you don’t receive cash back but your liability goes down, that will be considered income to you just like cash. For instance, if you had a mortgage of $500,000 on the old property and the mortgage on the new property is $400,000 then you have $100,000 of gain that will be taxed.
Doing A 1031 Exchange For A Vacation Home – You can sell your primary residence and shield $500,000 in capital gains as long as you lived in the property for two years out of the past five. However, this break isn’t available for your second or vacation home. Tax payers can turn vacation homes into rental properties and do 1031 Exchanges. For instance, if you want to stop using your beach house you can rent it out for six months or a year and exchange it for other real estate. But if you merely hold it out for rent and never actually rent it out it probably won’t qualify for a 1031 Exchange. The more time that elapses after you convert the property’s use the better.
If you or someone you know is interested in buying or selling
a Nashville Greek Revival Style Home please contact:
The Lipman Group | Sotheby’s International Realty
Office: (615) 463-3333 / Cell: (615) 509-1753