What Is a 1031 Exchange?
While a 1031 exchange (also called a like-kind exchange or a Starker) encompasses many different components, the short answer is that it is a way for people to buy and sell investment type properties in order to defer income tax on the financial gain of the property.
For many, this is known as the ultimate tax shelter when it comes to buying and selling real estate investments. While this is a beneficial vehicle for many, 1031 exchanges do not work for everyone.
An in-depth conversation with your tax advisor and attorney should be able to determine whether a 1031 exchange will work for you. There are many things to consider like your current tax profile and other financial transactions that you have taking place. In some instances, simply taking the capital gains can outweigh the fees that are associated with this type of transaction.
Who Can Participate in a 1031 Exchange?
Short answer, a qualified taxpayer. Any individual or business entity. If the transaction will be run through a business entity, it’s important to know that the legal title must be the same for both ends of the transaction. When you sell the property and again when you buy a replacement property.
Who Runs the Show on an Exchange?
So you’ve taken the necessary steps and have determined that 1031 exchanging your property will be the best option the next thing to do is to find a reputable accommodator. Many well-known title companies offer a department specifically dedicated to these types of transactions. While there are independent companies out there offering services, it’s important to do your due diligence on whomever you choose to be sure they are licensed, insured and have a good track record in the area you are doing business in.
A 1031 Exchange Example:
Say you’ve owned a rental property for at least 2 years and you’ve seen some great appreciation. You’ve decided it’s time to sell for a profit. You place the property on the market, get an offer and close the deal. Now that the property is sold you must move quickly to identify another buying opportunity.
The whole purpose of the 1031 exchange is you must sell your Investment and then immediately identify a replacement property or properties that you would like the proceeds to be used against. Since you are taking all the profit from one and rolling into another, this is how the 1031 exchange benefits the seller.
Once you’ve sold your property and recorded the clock starts. You have 45 days to identify another prospective property you intend on purchasing then another 135 days to close the transaction. These are hard days and are not in any way negotiable. During the identification period, the accommodator will be holding your funds in an account since they are acting and facilitating the transaction on your behalf.
What Properties Can Be Included in a 1031 Exchange?
Real Property like a single-family home, apartment complex or strip mall. These are properties that must be used as pure investment type properties. Unfortunately, a primary residence, 2nd homes or vacation homes are not counted as investment properties. Personal property can also be bought and sold within a 1031 exchange, however, there are restrictions. Examples would include the sale of an airplane to purchase another airplane, Boats, business equipment and farm equipment they have to be like transactions.